Thursday, October 16, 2008

Ilargi: So Dick Cheney has an abnormal heart rhythm. Well, ain’t that a shocker. They electrocuted him back to "life". Makes you think of Mary Shelley, don't it?

I watched parts of the debate last night, trying hard not to fall asleep. Jon Stewart must be secretly praying it won’t be Obama. That’s the most boring man we've seen in ages.

McCain is much better. Looking at him last night, I couldn't get rid of the impression that I was watching lipstick on a lizard.

That fake smile, the pale transparent skin, you just got to wonder what drugs that guy is on.

And all the time, I’m waiting for a 3 meter tongue to lash out, pick an insect off Bob Schieffer’s desk, and chew it up behind the lipstick.

Yes, I know, turn to economics. That’s what we do here. Well...

European exchanges plummeted once more, but since it was "only" 5-6% today, who’s surprised or alarmed anymore? "Better than expected" is a great way to put awful news in a sexy gift-wrap. The Dow Jones today is veering up and down like a junkie in between fixes, and we all know what that means: the little man is being relieved from the burden of actually having resources.

To know what is really going on, we have to get back to the real people I was talking about. • US manufacturing notes the biggest plunge in 34 years. Hey, back then, at least we still had manufacturing.• Banks’ numbers look awful, but wait for it: “Better than expected”.• The New York Times runs a major piece that says American home prices have much further to fall

They can push a trillion dollars down every bankers throat, but it won’t make any difference. These boyos make mullah off lending money to people. And the people are already in waaay over their heads. So in order to be able to afford a "healthy" loan, Joe the plumber has to get out of debt first. How will he do that? Why, by manufacturing things of course. Oh wait, that’s the sector (well, the part that hasn’t been outsourced yet) that is collapsing. Sorry Joe. Back to the trailer park for you.

"We’re going to produce green vehicles on American soil", right, Barack? How many milllions are you willing to bet that will NEVER happen? Reptile McCain wants to buy up "bad" mortgages. But at what price? Down 10%, 20%, 80%? i bet he thinks 20% off is good enough, but what then if prices keep on falling? You’d have people too poor or too smart to buy a home, being forced to pay for their bloated neighbor to continue living in their Flipper Mansions. That’s a recipe for major mayhem.

The NYT article recognizes that prices will keep falling, but not by how much. As my regular readers know, Meredith Whitney, the princess of Wall Street, has already stated that we will end up "well south" of a 40% drop. She’s about the only one to say that in the "serious" world.

Except for me, but then I'm in the real world, and she'll catch up. I have said all along that the drop will be 80% or more. And all this time, no-one has stood up to explain why the plunge would stop at 40%, bad enough as that is. Why and where would it halt? Come one. challege me....

It’s not that hard. Take another look at this 2006 graph from the imcomparable ContraryInvestor.

Look at the trendline, and than add that the downturn oscillation will be as strong as the upturn one (they tend to do that). The drop will not stop at 30% or 40%. Don’t bet your savings on it. Or your kids’ college funds, or your health care.

Update 7.00 PM EDT Ilargi: I'm surprised to see that Reuters also calls McCain a lizard, on account of this pic. I thought maybe it was just me having that impression last night.

The American housing market, where the global economic crisis began, is far from hitting bottom. Home prices across much of the country are likely to fall through late 2009, economists say, and in some markets the trend could last even longer depending on the severity of the anticipated recession.

In hard-hit areas like California, Florida and Arizona, the grim calculus is the same: More and more homes are going up for sale, but fewer and fewer people are willing or able to buy them. Adding to the worries nationwide are rising unemployment, falling wages and escalating mortgage rates — all of which will reduce the already diminished pool of would-be buyers.

“The No. 1 thing that drives housing values is incomes,” said Todd Sinai, an associate professor of real estate at the Wharton School at the University of Pennsylvania. “When incomes fall, demand for housing falls.” Despite the government’s move to bolster the banking industry, home loan rates rose again on Tuesday, reflecting concern that the Treasury will borrow heavily to finance the rescue.

On Wednesday, the average rate for 30-year fixed rate mortgages was 6.75 percent, up from 6.06 percent last week. While banks are moving aggressively to sell foreclosed properties, the number of empty homes is hovering near its highest level in more than half a century. As of June, 2.8 percent of homes previously occupied by an owner were vacant. Nearly 1 in 10 rentals was without a tenant. Both numbers are near their highest levels since 1956, the earliest year for which the Census Bureau has such data.

At the same time, the number of people who are losing jobs or seeing their incomes decline is rising. The unemployment rate has climbed to 6.1 percent, from 4.4 percent at the end of 2007, and wages for those who still have a job have barely kept up with inflation. In New York and other cities that rely heavily on the financial sector, economists expect that job losses will increase and that pay heavily tied to year-end bonuses will decline significantly.

One reliable proxy of housing values — the ratio of home prices to rents — indicates that in many cities prices are still too high relative to historical norms. In Miami, for instance, home prices are about 22 times annual rents, according to analysis by Moody’s Economy.com. The average figure for the last 20 years is just 15 times annual rents. The difference between those two numbers suggests that a home valued at $500,000 today might be worth only $341,000 based on the long-term relationship between prices and rents.

The price-to-rent ratio, which provides one measure of how much of a premium home buyers place on owning rather than renting, spiked across the country earlier this decade. It increased the most on the coasts and somewhat less in the middle of the country. Economy.com’s calculations show that while it remains elevated in many places, the ratio has fallen sharply to more normal levels in places like Sacramento, Dallas and Riverside, Calif.

The current housing downturn is much more national in scope and severe than any other in the postwar period, partly because of the proliferation of risky lending practices. Today, foreclosures are running ahead of the downturn in the economy, a reversal of previous housing slumps. “We are in uncharted waters,” said Brian A. Bethune, an economist at Global Insight, a research firm.

Colleen Pestana, a real estate agent in Orange County in California, said many people losing their homes in Southern California used to work at mortgage and real estate companies. Many of them bet heavily on real estate by upgrading to bigger houses every few years. Now, many are losing their homes. At the same time, Ms. Pestana said, her clients who are looking to buy are having a harder time lining up financing. One of her clients recently had to give up on a home after the lender that had offered a pre-approved loan changed its mind — a frequent occurrence, according to real estate agents and mortgage brokers.

“I am working harder than I have ever had to work to get a deal together and keep it together,” said Ms. Pestana, who has been a real estate agent for seven years. To cushion themselves from potential losses if homes lose value, Fannie Mae and Freddie Mac, the mortgage finance companies that the government took over in September, have increased fees on loans made to borrowers who have good but not excellent credit records, even those who are making down payments as big as 30 percent.

Those higher fees are generally invisible to borrowers because banks factor them into mortgage interest rates. While the national average rate for a 30-year fixed-rate mortgage is now 6.75 percent, according to HSH Associates, mortgage brokers say the rates for many borrowers in the Southwest or Florida can be as high as 8 percent, especially for so-called jumbo loans that are too big to be sold to Fannie Mae and Freddie Mac. (Those loan limits vary by area from $417,000 to roughly $650,000.)

Higher interest rates result in bigger monthly payments, pricing some potential buyers out of the market. For example, monthly payments are $2,700 on a 6 percent 30-year, fixed-rate loan of $450,000. If the interest rate rises to 7 percent, those monthly payments jump to $3,000. All things being equal, when rates rise prices generally fall.

This month, Fannie and Freddie canceled a fee increase that would have applied to markets where home prices are falling, but the companies still have many other fees in place. In an effort to help drive down rates, the Treasury Department has announced plans to buy mortgage-backed securities issued by Fannie and Freddie. The government also recently increased the amount of loans the companies can buy and hold.

Still, those efforts will take time to have an impact and it is not clear whether they will be sufficient to get banks to lend more freely, especially in areas where jumbo loans make up a bigger percentage of lending, like New York and parts of California and Florida. Economists say that prices in those places will probably fall further. In some of those places, price declines are being driven by a sharp increase in sales of foreclosed homes.

Hudson & Marshall, a Dallas-based auctioneer that holds sales for lenders, reports that banks are accepting prices that they refused to consider just 12 months earlier. In a recent auction of 110 foreclosed homes in the Las Vegas area, for instance, the auctioneer’s clients accepted 90 percent of the bids submitted by buyers, up from 60 percent a year earlier, said David T. Webb, a co-owner of the company.

Single-family home prices in Las Vegas have already fallen 34 percent from their peak in the summer of 2006, according to the Standard & Poor’s Case-Shiller home price index. Prices in San Diego have fallen 31 percent since late 2005. While those declines have been painful to homeowners in those cities, economists said the quick decline might help the markets reach bottom faster than in previous housing cycles, said Edward E. Leamer, an economist at the University of California, Los Angeles. In a previous boom, home prices peaked in the Los Angeles area in 1990 but did not hit bottom until 1996. Prices remained near that low for more than a year before starting to climb again.

“In some areas of California, we are really at appropriate levels,” Mr. Leamer said of current home prices. But he added: “The risk is that we are going to get some overshooting, meaning that prices will be lower than they ought to be.” In Florida, Jack McCabe, a real estate consultant, said that while some cities, like Fort Myers, are showing tentative signs of a rebound, others like Miami and Fort Lauderdale are still under pressure. Two homes on his street in Fort Lauderdale that sold for about $730,000 apiece in 2005 recently sold for $400,000 — a 44 percent decline. “The rocket has run out of fuel, and now it’s plunged back down to earth,” he said.

Production at the nation's factories fell into a virtual tailspin in September, declining by the largest amount in nearly 34 years, according to a report released by the Federal Reserve on Thursday. Production for all industries fell by a seasonally adjusted 2.8% from the previous month. The decline represented a far greater loss than the economists' consensus estimate of a 0.8% decrease, according to Briefing.com. "This is consistent with a recession, there's no doubt about it," said John Silvia, chief economist for Wachovia.

The report said the enormous decline was in most part due to hurricanes Gustav and Ike's disastrous effects on the Gulf Coast industry. Mining output took a 7.8% nosedive due to the storms, and oil and gas-related production fell as well. But the impact was even greater than that of hurricanes Katrina and Rita in 2005, which resulted in a 1.8% decline in industrial production. Even without the impact of the hurricanes and a Boeing plant strike, which also curtailed total industrial output, national production still would have slumped.

Industrial production is one of the four factors that the National Bureau of Economic Research considers to determine if the nation's economy has fallen into a recession. The other three factors are employment, personal income and retail and wholesale sales of manufactured goods. Though industrial production has been volatile over the past year and a half, registering up-and-down growth since January 2007, it has only recently shown the kind of huge drop off that is typical in a recession.

After slight rises in manufacturing in June and July, production tanked a whopping 1.1% in August on a sizeable drop auto manufacturing. Production fell for 12 straight months during the 2001 recession. The Fed said for the third quarter, production fell 6%, nearly doubling the 3.1% decline of the second quarter. "Industrial production is a key input into the overall output of the U.S. economy," Silvia said. "For all practical applications, there is a one-to-one correspondence between production and how the economy is growing." "GDP is gross domestic product, and this is a measure of production," he added.

In other troubling news, The Philadelphia Federal Reserve reported that its regional manufacturing index decreased by 41.3 points, to minus 37.5 from positive 3.8 in October. It was the largest one-month decline in the history of the index. Economists polled by Briefing.com expected a decline of just 5 points. The report also showed that industrial capacity utilization - a measure that tracks the percentage of factories in use - posted a seasonally adjusted decrease of 4.6% to 76.4%. Economists had expected a decrease of just 0.7% to 78%.

Manufacturing output decreased 2.6% in September, and the factory operating rate fell to 74.5%, which is more than five percentage points below the average from 35-year average from 1972-2007. "Over the last six months we have seen utilization declines in manufacturing and mining," Silvia said. "Historically, lower capacity utilization rates have been consistent with weaker corporate profits."

Manufacturing in the Philadelphia region shrank in October at the fastest pace in almost two decades, a sign the worsening credit crush is pushing the economy into a deeper slump. The Federal Reserve Bank of Philadelphia's general economic index plunged to minus 37.5 this month, less than forecast and the lowest reading since October 1990, from 3.8 in September, the bank said today. Negative readings signal contraction. The index averaged 5.1 last year.

The decline signals manufacturing isn't recovering after a separate report showed industrial output dropped in September by the most in almost 34 years. More reductions in production are likely as job losses and tougher lending rules hurt sales. "The manufacturing sector, which had already been feeling pain for several months, is now suffering pronounced weakness as domestic demand craters and export growth slows substantially," said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York.

Economists expected the Philadelphia index to fall to minus 10, according to the median of 54 forecasts in a Bloomberg News survey. Estimates ranged from 5 to minus 25. Production at factories, mines and utilities dropped 2.8 percent in September, exceeding forecasts and following a revised 1 percent decrease in August, the Fed said today. Last month's Gulf Coast hurricanes accounted for 2.25 percentage points of the decline and a strike at Boeing Co. subtracted another half point. The decline in output was the biggest drop since December 1974.

The Philadelphia Fed's index of new orders slumped to minus 30.5, the lowest level since August 1980, and the shipments index decreased to minus 18.8 from 2.6. The gauge of prices paid declined to 7.2, the lowest level since July 2003, after 31.5 the prior month, indicating that prices rose at a slower pace. An index of prices received was 5.3, down from 15.5. The employment index was minus 18 after being little-changed in September.

The headline index is a separate question unrelated to the individual measures and some economists consider it a gauge of business sentiment. Expectations for the next six months fell to minus 4.2 from 30.8, today's report showed. The New York Fed yesterday reported its Empire index of manufacturing sank in October to the lowest level since records began in 2001. The regional surveys provide early clues to the health of manufacturing nationwide, which accounts for about 12 percent of the economy.

Stock markets around the world suffered another day of huge losses yesterday as fears of the global recession spreading to China prompted a renewed bout of negative sentiment. The FTSE 100 index of leading UK companies lost more than 7 per cent and the Dow Jones Industrial Average in the US was down by almost 6 per cent by mid-afternoon.

The gloom in credit crunch-hit Western economies deepened with UK unemployment figures showing a 164,000 rise in the three months to August, and US reports of the biggest monthly fall in retail sales for more than three years. The sell-off overshadowed Gordon Brown's attempts to convene a global summit to tackle the economic crisis. There were also renewed concerns for the financial health of local authorities in Britain who have been hit by the collapse of banks in Iceland.

The sell-off was prompted in part by warnings that China's economy, which has been expanding at breakneck speed for years, would "pause for breath". Guy Elliott, the finance director of Rio Tinto, the mining giant, said: "We are confident about the future in China, but at the moment there is a deceleration of demand that won't pick up again until next year." His comments caused panic in the commodity markets. The oil price dropped by 5 per cent to a 13-month low, and copper, aluminium and nickel all slumped. Only gold, seen as a safe haven in troubled times, stayed stable.

Economists are already cutting forecasts for China. The International Monetary Fund (IMF) last week predicted growth of 9.7 per cent this year and 9.3 per cent in 2009. The danger is that the health of China's economy is hard to measure, and Beijing's economic policy even harder to predict.

And just as its semi-command economy was central to the cheap-credit era that is now causing such a hangover in Western economies, so its response to the aftermath is the key to the world's recovery, said Diana Choyleva, a director at Lombard Street Research, a think-tank. "The combination of macroeconomic data and anecdotal evidence, such at that from Rio Tinto, gives an ambiguous message because GDP data for the first two quarters of the year do not show anything yet," she said. "But China has to have a slowdown and what is important is how Chinese policymakers respond."

Mining stocks, which have been boosted by China's rampant demand for commodities, were hit particularly hard. Concerns about weakening demand from the global powerhouse wiped 16.6 per cent off Rio Tinto's value by the end of the day – and 19.6 per cent and 22.27 per cent were knocked off the value of Xstrata and Kazakhmys respectively.

China's economic growth – which ran at 11.7 per cent last year – is a key factor in the high oil and commodity prices causing extra problems for developed economies wrestling with toxic combination of the credit crisis and slowing consumer spending. But if China follows the West into recession, the effect could be even more severe.

But it is too early to tell to what extent the West's recession will infect China, and even at about 9 per cent, the economy is still growing fast. Robin Geffen, the manager of the Neptune China Fund, says the impact of developed economies' demand is overplayed. "Not only is the rest of Asia geared towards China but it has very fast-growing domestic consumption as a percentage of GDP and a massive infrastructure spend," he said.

The Chinese government has been deliberately slowing growth through tight economic policies for the past 12 months to cool off an otherwise overheating economy. Loosening monetary policy would have real effect, as would using some of the vast reserves of cash.

"Monetary policy in particular has been quite tight recently – such as not allowing the money supply to grow anywhere near as fast as industrial output and leaning on the banks to control lending," said Ian Beattie, the manager of New Star's Asia Pacific Fund. "There is a lot of firepower in both monetary and fiscal policy."

Ilargi: This is from the Guardian. While I like the fact that China’s banking system is scrutinized, the writer misses the main point about the banks. Chinese banks are in huge peril because they have -for westerners- unbelievable high numbers of bad loans in their books. When the country’s economy stops growing at present rates, re: 2009, they’ll have to write off tons of those loans. That’s when the vulnerability of the sytem will come to light.

Is Chinese premier Wen Jiabao right to say that the credit crisis will have a negligible impact on China because its banks have limited involvement with global capital markets?

'We are confident that we can maintain the stability of Chinese financial markets,' says Jiabao in a statement on the Chinese foreign ministry website. He adds that the biggest contribution China can make is to keep its economy growing in a stable and fast manner. Quite So.

Assuming that the Chinese haven't been playing in the derivatives market or investing in 'toxic' US mortgage-backed securities, a systemic collapse of China's banks seems unlikely, especially as the country is sitting on hundreds of billions of dollars in foreign exchange reserves.

But comments from the ministry of commerce, quoted in the official Xinhau news agency, should be treated with more scepticism. A spokesman says: 'many Chinese export products are daily necessities, so we don't think that a slowdown in major economies will cause a sharp fall in demand for these products.'

Really? But western consumers have been huge buyers of Chinese finished products that include furnishings, furniture, toys, clothing and sports equipment. The truth is that Chinese industry, and employment, are going to suffer in the looming global recession as China's customers in the west rein back on spending in a way that will soon become painfully obvious.

U.S. Treasury Secretary Henry Paulson said his plan to inject capital into financial companies is focused on banks and thrifts, indicating unregulated firms such as hedge funds won't initially get government aid. "Right now we're focused on financial institutions, regulated financial institutions," Paulson said in an interview with Bloomberg Television, when asked whether hedge funds might also be eligible. "The program right now is for banks and thrifts."

Paulson pushed Congress to pass a financial rescue package that gives him broad authority to pump money into cash-strapped banks. Earlier this week, he said the first $250 billion of the overall $700 billion rescue would go into the balance sheets of financial companies in exchange for non-voting, preferred equity. U.S. stocks have fallen for three straight days since Paulson's Oct. 14 announcement of the equity purchases. The Standard & Poor's 500 Index yesterday dropped 9 percent and fell much as 3 percent today.

"You don't want to react too much to the equity market any single day," Paulson said in the interview. "But if you look at credit spreads, if you look at some of the indicators that I look at every day, there's no doubt in my mind we've done the right things."

The European Central Bank has taken dramatic action to unblock the credit markets, flooding the system with $170bn of dollar liquidity and accepting junk bonds as collateral at its lending window. "The ECB is doing whatever it takes to unclog the interbank market," said Gilles Moec, from Bank of America, who described the move as "spectacular" volte-face and a belated recognition that the credit crisis is deadly serious.

The monetary blitz was welcomed in Brussels, where EU leaders were meeting yet again, just days after agreeing to the most comprehensive bank bail-out in history. "We are not at the end of the crisis, we are still living in dangerous times," said Jean-Claude Juncker, Luxembourg premier and Eurogroup chair. He issued a stark reminder that life is going be very different for the banking elite as governments move to restore the lost discipline of the Bretton Woods financial order and attempt to "civilise" capitalism, the code word for clamping down on the City – dubbed "the Casino" in Europe.

"Let everyone remember after this crisis, who solved it. Politicians did, not bankers," he said. Mr Juncker added that this episode would have a profound effect on the euro debate in Britain. "The British prime minister had to beg to be let into the room. I'm sure that when the storm is over, the British will think about whether they shouldn't become an equal in all decision-making bodies."

German Finance Minister Peer Steinbrück echoed the warning. "When a fire's burning in the global financial markets, it has to be put out, even if it's a case of arson. But then the arsonists have to be held responsible, and spreading flames must be outlawed." In a key change, the ECB is providing unlimited liquidity for longer-term loans to force down the market rates used to price mortgages in the Eurozone. The aim is to help banks pass along last week's half-point cut in interest rates before the region's economy starts to seize up altogether.

The standard for collateral has been slashed from A- to the once unthinkable level of BBB-, allowing distressed banks to offload securities that cannot be sold on the open market. It greatly widens the range of instruments and – crucially – lets banks use their dollar assets for the first time. The radical shift in policy suggests that the ECB is now deeply alarmed by the crunch facing European banks as a violent unwinding of debt leverage across the world forces them to repay huge sums in dollars.

Goldman Sachs estimates that non-US banks have liabilities of $12 trillion (£6.8 trillion) on dollar balance sheets. The European, British, and Swiss banks make up the lion's share, and they have used leverage far more aggressively than US banks. Analysts say the European banks will need to raise $400bn in fresh capital – no easy feat at a time when burned investors are keeping their distance.

The American banking sector is far from being "out of the woods" despite the US government's plan to inject $250bn (£144bn) into the nation's financial institutions, warns leading analyst Meredith Whitney. Ms Whitney, who played a crucial role in the downfall of Citigroup chairman Chuck Prince just under a year ago, believes that US Treasury Secretary Hank Paulson's latest response to restore confidence in the banking system is not the panacea some have presented it to be.

The Oppenheimer analyst, well known for her bearish view on the sector, believes that although the move by Mr Paulson – one of several aimed at rebuilding trust in America's bank – is a step "in the right direction for US markets," it is not the final solution. "We are at least several quarters away from stabilising fundamentals," said Ms Whitney, who is still worried about credit cost and availability and the ability of banks to be able to produce profits in the way that they have in recent years.

She is also concerned that many of the banks who receive a balance sheet injection from the US Treasury will hoard the money in reserves, rather than putting it to work. The extent of the problems that remain in the banking sector were highlighted on Wednesday by quarterly results from JP Morgan Chase and Wells Fargo, which both report sharply lower profits. JP Morgan Chase saw profits fall in the three months to September plunge by a bigger-than-expected 84pc to $527m, - struck after a further $5.8bn of writedowns, losses and credit provisions.

Jamie Dimon, chairman and chief executive, warned that he expects all the bank's business lines to be hurt as a result of the slowing global economy: "We have to be prepared that it gets a lot worse." The results included $640m of losses linked to the bank's September takeover of troubled savings and loans bank Washington Mutual, with the overall results including a $1.2bn charge on the acquired institution's loan-loss reserves. But JP Morgan's existing business also suffered, with Celent analyst Bart Narter noting that around 18pc of its $13.4bn sub-prime mortgage book is non-performing.

At Wells Fargo, the Californian bank which recently fought off Citigroup to take control of Wachovia, profits in the third quarter tumbled by 24pc to $1.64bn, although earnings per share of 49 cents comfortably topped analysts' expectations. Chief executive John Stumpf stressed that the bank, which becomes a much larger player in the American banking scene as a result of its Wachovia takeover, retains a "conservative financial position."

Federal Reserve Chairman Ben Bernanke on Wednesday gave a dour assessment of the U.S. economy, emphasizing a "significant threat" from turmoil in credit markets in remarks that suggested more interest-rate cuts could be coming.

Bernanke said it will take some time to restore normal credit flows and pledged the U.S. central bank would continue to act aggressively to fight the crisis. Importantly, he said inflation risks were ebbing, which suggests Fed officials see latitude to lower borrowing costs further. "By restricting flows of credit to households, businesses, and state and local governments, the turmoil in financial markets and the funding pressures on financial firms pose a significant threat to economic growth," Bernanke told the Economic Club of New York.

"We will continue to use all the tools at our disposal to improve market functioning and liquidity," he said, adding that policy-makers' aggressive and quick response crucially distinguished this episode from the crisis of the 1930s. Another senior Fed official, Vice Chairman Donald Kohn, echoed Bernanke's downbeat view of the growth outlook and his qualified relief on prices, saying inflation seems "likely to move onto a downward track."

Kohn further said that any effect last week's emergency interest rate cut may have had on easing credit was "overwhelmed" by escalating mistrust among financial institutions unwilling to lend to one another. U.S. stocks, already down sharply on Wednesday on news of an unexpectedly big drop in September retail sales and weak factory data, sold off even more after Bernanke's remarks and finished the day with their largest percentage losses since the 1987 crash.

St. Louis Federal Reserve Bank President James Bullard said the sharp 1.2 percent drop in retail sales increased the risk of recession. "The third quarter, I think, will be flat to slightly negative," he told reporters in Little Rock, Arkansas. "That is going to push up the probability that it will later be named a recession." The data contributed to expectations that Fed officials will follow up the emergency interest rate cut made last week with another reduction at their scheduled next meeting on October 28-29.

Last week, in concert with central banks around the globe, the Fed cut benchmark rates by a half point to 1.5 percent. It said an intensification of the financial crisis had raised risks to growth, while curbing the risk of inflation. In the latest bid to restore financial market stability, the U.S. government on Tuesday announced a dramatic plan to recapitalize banks, beginning with a $125 billion equity investment in nine major financial institutions.

But even with the government scrambling to restore credit, Bernanke cautioned it will take time for the economy to heal. "Stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away," he said. Analysts said Bernanke's words suggested the Fed chief saw the deteriorating outlook as calling for another rate cut. "Bernanke's comments ... reinforce the sense that the Fed will lower interest rates when it meets again," said Tony Crescenzi, chief bond market strategist at Miller, Tabak & Co in New York.

A Fed report prepared for the central bank's next meeting added to the gloomy news about the economy. The Beige Book said economic activity had weakened across the country in recent weeks as businesses revisited capital investment plans, consumers curtailed spending and labor markets softened. The Fed described business contacts as "pessimistic." In his speech, Bernanke said the housing sector remained the economy's weakest spot, but he also cited "marked slowdowns" in consumer spending, business investment and the labor market.

He added that credit markets would take time to unfreeze and said export sales, until recently a bright spot, were likely to slow as well. While inflation had been high recently, Bernanke said expectations of future inflation had held steady or eased, import prices were moderating and commodity prices had fallen. Those factors, along with the softness in the economy, "should lead to rates of inflation more consistent with price stability," he said. "I think the evidence is now in that the inflation problems are moderating and look to be returning to price stability at a reasonable pace."

Boston Fed President Eric Rosengren was more direct. "One of the characteristics of a recession is in each of these recessions the inflation rate has come down quite dramatically," he told a real estate group in Boston. "We're in a period when the economy is likely to grow quite slowly. The events of the last couple of weeks certainly aren't going to help."

Chancellor Angela Merkel defended her 500-billion euro bank rescue package against jeers from left-wing opponents on Wednesday, calling it an essential step that would shield average Germans from the global crisis. Merkel told parliament the international financial crisis would weigh on the economy but not lead to a lasting slump.

"We have to expect a weakening of growth," she said. Merkel added, however, that a sharp, sustained economic downturn was not on the horizon. "We've seen...that the state is and has been the only institution capable of recreating trust between banks," she said. "That's happening to protect citizens and not to protect bank interests...We're taking up our responsibility to avert damage to the German people." Germany is expected to cut its growth forecast for 2009 to about 0.2 percent on Thursday, down from 1.2 percent before.

Finance Minister Peer Steinbrueck, who has said Europe's largest economy could slip into recession, told parliament the economy faced significant risks but there was no need to pursue a stimulus package to cushion it from the crisis. "We will enter a very difficult period in 2009," he said.

The far-left Left Party, a rising force in German politics, sharply criticized the crisis management of the ruling grand coalition of Merkel's Christian Democrats (CDU) and Steinbrueck's Social Democrats (SPD). Left party leader Oskar Lafontaine called for measures to boost domestic demand, adding many Germans found the cabinet's multi-billion bank rescue package hard to fathom as they suffered the effects of a weakening economy.

"When we asked for more money for Hartz IV (unemployment benefits), the answer was 'There's no money'. When we asked for more money for pensioners, the answer was 'There's no money'," Lafontaine told parliament. "People are surprised that, all of a sudden, 500 billion euros are readily available to manage the crisis...The people doesn't understand that any more," he said.

Guido Westerwelle, leader of the opposition Free Democrats (FDP), warned the government not to give up their target to curb spending and balance the budget over the crisis. "Solid state finances must not be laid to rest to the detriment of the next generation," he told the assembly. Merkel defended her cabinet's approval of the bank rescue plan, which includes as much as 400 billion euros in guarantees to help banks get over a liquidity squeeze and up to 100 billion euros in state funds, mainly to recapitalize banks.

Merkel said Germany would push for new global rules for the financial system, reiterating her demand that the International Monetary Fund (IMF) take on a bigger supervisory role. She said Germany would set up a new expert group, which would assess the financial market system. Merkel's announcement that former Bundesbank president Hans Tietmeyer was to head the group drew jeers from Lafontaine's Left Party, which has sharply criticized Germany's banking elite in past weeks.

The Swiss government on Thursday became the first to take troubled assets off a bank balance sheet, reaching a deal to absorb up to $60 billion in mostly mortgage-related assets from UBS. In addition, the Swiss government is taking a 9% stake in UBS in return for a 6 billion franc ($5.25 billion) injection into the world's largest asset manager.

And rival Credit Suisse is being forced to raise billions as well to meet new adequacy standards, though it's been able to do so by turning to key shareholders, notably the government of Qatar. The Swiss National Bank said the moves by the country's banking giants "will result in a sustainable reduction of strains in the Swiss financial system. The stabilization thus reached will be favorable for the development of the Swiss economy as a whole and is in the interest of the country."

The move by the Swiss government is more in line with the original proposal of U.S. Treasury Secretary Henry Paulson's Troubled Asset Relief Program than the current version, which calls initially for direct injections into U.S. banks. Like a related British plan, it gives banks the choice of raising money privately or publicly. In midday Zurich action, UBS shares rose 2.3% and Credit Suisse jumped 7.2%. But over the last year, UBS has dropped 65% and Credit Suisse has fallen 38%.

The pool of assets that UBS is offloading contains mostly debt backed by U.S. residential and commercial mortgages. UBS also is throwing in other U.S. asset-backed and auction-rate securities, notably those backed by student loans, as well as European and Asian bonds. UBS is going to sell the securities it doesn't want into a special-purpose vehicle, into which it will inject $6 billion to cover the pool's losses. The Swiss National Bank will then provide a loan of up to $54 billion to pay for the assets.

UBS will be able to claw back the profits from the pool, but it will have to repay the loan and hand over $1 billion and 50% of the remaining equity value to the central bank. "In these turbulent times we want to ensure that we do everything possible to safeguard the solidity of our bank. We are taking practical steps to eliminate legacy risks," said Peter Kurer, chairman of UBS, in a statement.

Credit Suisse meanwhile is raising 10 billion Swiss francs, through the sale of 3.2 billion francs of shares, 1.7 billion francs of mandatory convertible bonds and the issuance of 5.5 billion francs of non-dilutive hybrid Tier 1 capital. Credit Suisse said the move will bring its Tier 1 capital ratio, a way of measuring a bank's capital adequacy, to 13.7% from 10.4% at the end of the third quarter.

"Over the past few months we have had a constructive and close dialog with regulators about future capital requirements. We are very pleased to have reached a solution that further strengthens our capital base and ensures our competitive position," said Credit Suisse CEO Brady Dougan. UBS said it had a Tier 1 ratio of 10.8% at the end of the third quarter and said that would rise to 11.5% by the end of the year. The pair also provided more details of their third-quarter performance.

UBS said it earned 296 million francs, in line with its earlier announcement of a "small profit," mostly on its global wealth management and business banking division but also on the global asset management division. That helped offset a 2.75 billion loss before tax from investment banking. Credit Suisse said it expects to lose about 1.3 billion francs due to a 3.2 billion loss before tax from its investment bank. It took a write-off of 2.4 billion francs in the leveraged finance and structured products businesses and the "exceptionally adverse trading conditions in September."

Amid the chaos of recent days, as the federal government has taken gargantuan steps to stabilize the financial markets, realigning the U.S. economic system in the process, comes a nearly universal consensus: This crisis resulted from government reluctance to regulate the unbridled greed of Wall Street. Many economists and market participants who were formerly averse to government interference agree that a more robust regulatory framework must be constructed to cage the destructive forces of capitalism.

For the political left, which has long championed the need for such limits, this crisis is the opportunity of a lifetime. Absent from such conclusions is the central role the government played in creating the crisis. Yes, many Wall Street leaders were irresponsible, and they should pay. But they were playing the distorted hand dealt them by government policies. Our leaders irrationally promoted home-buying, discouraged savings, and recklessly encouraged borrowing and lending, which together undermined our markets.

Just as prices in a free market are set by supply and demand, financial and real estate markets are governed by the opposing tension between greed and fear. Everyone wants to make money, but everyone is also afraid of losing what he has. Although few would ascribe their desire for prosperity to greed, it is simply a rose by another name. Greed is the elemental motivation for the economic risk-taking and hard work that are essential to a vibrant economy.

But over the past generation, government has removed the necessary counterbalance of fear from the equation. Policies enacted by the Federal Reserve, the Federal Housing Administration, Fannie Mae and Freddie Mac (which were always government entities in disguise), and others created advantages for home-buying and selling and removed disincentives for lending and borrowing. The result was a credit and real estate bubble that could only grow -- until it could grow no more.

Prominent among these wrongheaded advantages are the mortgage interest tax deduction and the exemption of real estate capital gains from taxable income. These policies create unnatural demand for home purchases and a (tax-free) incentive to speculate in real estate. Similarly, the FHA, Fannie and Freddie were created to encourage lending by allowing primary lenders to turn their long-term risk over to the government.

Absent this implicit guarantee, lenders would probably have been much more conservative in approving borrowers and setting interest terms, and in requiring documentation of incomes and higher down payments. Market forces would have kept out unqualified buyers and prevented home-price appreciation from exceeding the growth in household income.

Interest rates contributed the most to creating the housing boom. After the dot-com crash and the slowdown following the attacks of Sept. 11, 2001, the Federal Reserve took extraordinary steps to prevent a shallow recession from deepening. By slashing interest rates to 1 percent and holding them below the rate of inflation for years, the government discouraged savings and practically distributed free money.

Artificially low interest rates invigorated the market for adjustable-rate mortgages and gave birth to the teaser rate, which made overpriced homes appear affordable. Alan Greenspan himself actively encouraged home buyers to avail themselves of these seeming benefits. As monetary policy caused houses to become more expensive, it also temporarily provided buyers with the means to overpay. Cheap money gave rise to subprime mortgages and the resulting securitization wave that made these loans appear safe for investors.

And even today, as market forces deflate the credit bubble, the government is stepping in to re-inflate it. First came the Treasury's $700 billion plan to purchase mortgage assets that no one in the private sector would buy. Now it has recapitalized banks to the tune of $250 billion, guaranteeing loans between banks and fully insuring non-interest-bearing accounts. Policymakers say that absent these steps, banks would not be able to extend loans. But given our already staggering debt burden, perhaps more loans are not the answer. That's what the free market is telling us. But the government cannot abide solutions that ask for consumer sacrifice.

Real credit can be supplied only by savings, so artificial steps to stimulate lending will only produce inflation. By refusing to allow market forces to rein in excess spending, liquidate bad investments, replenish depleted savings, fund capital investment and help workers transition from the service sector to the manufacturing sector, government is resisting the cure while exacerbating the disease.

The United States reached its economic preeminence on the strength of its free markets. So far, the economic disaster exacerbated by government policies is creating opportunities for further government interference, which will lead to bigger catastrophes. Binding the country to a tangle of socialist ideals will seal our fate as a second-rate economic power.

A bad day on Wall Street lately is almost always a good day for the Japanese yen, whose appeal has an inverse relationship with risk appetite. "Currency traders hold great stock in the value of the low-yielding yen as a barometer of global risk," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group in Greenwich, Connecticut.

As the Dow Jones Industrial Average plunged more than 700 points Wednesday, marking its second-biggest point drop ever, the yen marched higher. In late trading, the dollar had slipped below the 100-yen level, buying 99.33 yen, down about 0.5%. The euro bought 133.45 yen, down about 1.1%. "It's no coincidence that the yen peaked against the dollar this year at the time of the Bear Stearns crash in March, when it reached 95.75 yen," said Wilkinson.

In recent years, the dominant theme affecting yen trading has been the carry trade, in which investors borrow lower-yielding currencies, such as the yen, and invest them in assets denominated in higher-yielding currencies, such as the Australian or New Zealand dollar. Such positions pressured the yen, because at 0.5%, Japan's benchmark interest rate is the lowest in the developed world.

But carry trades lose their appeal as risk aversion rises, and traders, fearing losses, liquidate their positions. The unwinding of yen-carry trades contributed to yen strength, despite Japan's still-rock-bottom interest rates. "The biggest beneficiaries of the sell-off in equities continue to be the two lowest-yielding [Group of Seven] currencies which are the U.S. dollar and the Japanese yen," said Kathy Lien, director of currency research at GFT in New York.

"Low yielders tend do well in times of slower growth / high volatility because high yield equals high risk, and when risk aversion is strong, people shed high yielding currencies that are funded by the low yielders," she said. The yen's upward sensitivity to risk aversion means it sometimes referred to as a "safe-haven" currency, which might be bit misleading. Unlike classic safe-haven investment instruments, such as U.S. Treasury bills, no explicit guarantees back a currency.

But the yen is indeed backed by Japan's current account surplus, which, though on a shrinking trend, remains formidable. The trend in Japan's monthly current account surplus measured by the three-month moving average of the seasonally adjusted data dropped from above 2 trillion yen in late 2007 to about 1.2 trillion yen in August 2008, according to Tomoko Fujii, head of economics and strategy for Japan at Bank of America in Tokyo.

"We expect the current account surplus to be flat to modestly higher in coming months. As lower foreign interest rates limit the upside for net income receipts, the direction of the current account will be mostly subject to trade balance developments. Since late 2007, upward pressure arising from the current account surplus has thus moderated," Fujii said in a note to clients Wednesday.

But despite the moderation, the yen is still "vulnerable to upside risks reflecting risk aversion" in the near term, due to Japanese investors' reduced appetite for foreign currency assets in light of rising global risks, she said. Bank of America measures Japanese retail investors' demand for foreign securities by taking the sum of investment trusts' foreign equity and note/bond investment and foreign note/bond investment from brokers and "other" investors in Ministry of Finance broker data.

The latest data showed net sales of 155.9 billion yen in September -- the first net-selling figure since the Ministry of Finance began to disclose the broker data in January 2005, Fujii said. "Historically, the Japanese retail investor has been relatively indifferent to global economic developments and has focused on relative yields. Now, with the growing turbulence in financial markets and the sharp rise in economic uncertainty, the risk appetite of the retail investor has been curbed," Tohru Sasaki, chief forex strategist at JPMorgan Chase Bank in Tokyo, wrote in a recent report to clients. "The yen, which has now become the strongest currency in the world, looks set for further appreciation," he said.

Let's be optimistic, or just flat out pretend, that Treasury Secretary Henry Paulson did not pick Neel Kashkari to run the bailout program just because he worked at Goldman Sachs Group Inc. Let's hope that the 35-year-old whiz kid was chosen interim assistant secretary for financial stability on Oct. 6 because he is the Rain Man of asset valuation who may or may not be able to tie his shoes but can estimate within a nickel the losses on Alt-A mortgage-backed securities held to maturity.

Kashkari as prodigy, not Kashkari as favoritism, is clearly what Paulsonites at Treasury and their allies at the Federal Reserve want us to believe, considering they bypassed offers from people with much longer resumes including New York City Mayor Michael Bloomberg, who's clearly worried about losing his job, and Bill Gross, the bond king at Pimco, who offered to do it for free.

Gross and Bloomberg may have a shot at the long-term job of running the fund. Kashkari, technically, is temporary and needs to be confirmed by the Senate. By picking any of them, Paulson believes, or doesn't care, if there's anyone out there who can help who isn't wrapped like a mummy in conflicts of interest. Our Treasury Secretary also seems to believe that in order to fix this mess, you have to have had a hand in creating it.

Whoever ends up at the permanent post will be getting the leftovers. Consider that 36% of the funds already have been spent. The rest almost certainly will be used to buy bum assets. So much for the "flexibility" Kashkari talked about last week in his first major speech after being named to the post. The asset-purchase part of the program is voluntary for participants. If someone other than Kashkari gets the job, they will be left with only the thankless task of digging through the garbage and trying to put a value on it.

If Kashkari is on the job, does anyone think Treasury will be driving a hard bargain with Goldman on its mortgage assets? And while we're on the subject of Goldman, under what criteria did Goldman and Morgan Stanley qualify as two of the nation's nine strongest financial institutions? Just wondering.

Kashkari has not done much to assuage the market or critics that he's too green for the job. He began his career as an investigator in the aerospace division at TRW. That part of his resume has led to a lot of clever remarks about the job needing and getting a rocket scientist. But Kashkari's record looks more like a failure to launch. He's advised Paulson on security and other issues at the Treasury Department since 2006, which would have been a good time to start thinking about the consequences of the housing market bubble bursting.

It does not take an egghead to connect the dots and conclude that mortgage defaults would have an impact on the derivatives built from them. Instead, Kashkari urged U.S. banks to start a covered-bond market like they had in Europe. They probably would have, had they not been edging toward collapse. Missing the bubble is a big reason why critics think Treasury is too narrow-minded in its approach to the crisis. When some in the market were advocating a plan to take stakes in U.S. banks, Paulson and Kashkari were advocating baby steps: a bailout here, a rescue there. That course would have been fine had they made provisions should the crisis deepen, which it did, in part, because there was no back-up plan.

It's no wonder that the world is scratching its head. Congress approved a bailout of bad assets and the Treasury Department has used it to buy stakes in preferred banks. Some of those banks, J.P. Morgan Chase & Co. and Bank of New York Mellon, look to be in decent shape. Others, such as Morgan Stanley and Goldman are highly leveraged firms that, regardless of what kind of charters they hold, are not too far from hedge funds.

The equity-for-cash plan that Paulson and Kashkari have implemented is the right way to go. Better to buy a bank dedicated to survival than its garbage. But let's be honest, they only did it because it was working in Europe. Paulson and Kashkari didn't have a choice. Ultimately, Kashkari is yet to prove himself as anything more than someone who can recognize a good idea that's working. On the surface, it may be good to know that Paulson isn't looking at the same tired, old retreads to get us out of this mess. There are no William Donaldsons or Roger Altmans. And thank God, there are, no Robert Rubins or Felix Rohatyns.

But to many investors and citizens, Neel Kashkari is just another Wall Street insider who has close ties to the Treasury chief. Kashkari joins Paulson, Josh Bolton, Steve Shafran, Ken Wilson, Dan Jester as former Goldman bankers who now saturate the administration's team handling the crisis. Kashkari came from humble beginnings, but he studied hard. You can guess the rest of the resume: Wharton Business School, homes on both coasts, he met Paulson and got his job by knowing the right people. He stayed up all night working on the bailout proposal even though the document, at a total of three pages, was politically inept and borderline unconstitutional.

He's young, but that doesn't mean he brings a fresh perspective or new and radical thinking. In short, he's really part of the elite that brought you The Biggest Financial Crisis Since The Great Depression. Bloomberg's done a good job both as a businessman and as mayor of the nation's biggest city. Bill Gross at Pimco might have his conflicts, but he knows a thing or two about bonds. If only either had worked at Goldman, maybe he would have landed an interview.

Iceland has food stocks for about 3 to 5 weeks, but needs quickly to restore a proper foreign exchange market so importers can get back to normal business and avoid shortages, importers said on Wednesday. Since crisis broke out on the north Atlantic island of 300,000 people, involving the government taking over the top three banks, suppliers to Iceland have cut credit to importers. Some have also demanded pre-payment for goods.

Though the central bank has said it has foreign reserves for eight to nine months of food, importers said a cash injection from abroad was the only solution to avoid shortages. They said Iceland imported about a half of its food products, but produced its own dairy products and meat. "The government has to get some currency in to back up the crown and build up credibility again," said Oli Johnson of the OJNK food importer, one of Iceland's biggest. "As soon as we can show we can pay without restrictions, things will open up again," Johson said. "Hopefully they plan to solve it in the next few days." He said Iceland on average had stocks of about 3 to 4 weeks.

The problem for importers was uncertainty about whether they would get foreign exchange, which they now have to apply for under a rationing system begun by the central bank. "The second problem is that we do not know what the exchange rate will be," he said. The central bank held a first auction to set the exchange rate on Wednesday and it was set at 150 crowns to the euro, versus 131 to the euro before currency trading halted last week.

Peter Thorginsson, chief operating officer of largest food importer, Olgerdin, said current food stocks would last about 4 to 5 weeks, with some supplies still coming in, he said. He did not anticipate major shortages, but said the situation could get acute if supplies to food producers, such as bakers, were affected. "They cannot produce if they are missing one or two ingredients," he said. On Tuesday, Iceland drew on Nordic help to get hold of 400 million euros ($546 million) and separately began talks with Russia over a possible multi-billion-euro loan. A team from the IMF is in Reykjavik, but Prime Minister Geir Haarde said on Tuesday that it was still an open question whether Iceland would borrow money from the Fund.

The Government has put Ernst & Young, the accountancy firm, on standby to step in as administrator of the UK assets of Landsbanki. The administration would have huge implications for the embattled British high street because a large part of it, including the Icelandic retail group Baugur, is funded by Landsbanki and its Icelandic rival Kaupthing Singer & Friedlander, of which Ernst & Young is already administrator.

The problems surrounding the future of the Icelandic-backed stores groups is becoming increasingly politicised. Baugur employs 55,000 staff and City sources say a £100 million loan granted by the Bank of England to the struggling Landsbanki on Monday helped to give the bank sufficent liquidity to start relending to the British retailers that banked there. The administration of Landsbanki would also have serious diplomatic repercussions for the already strained relationship between the UK and Iceland, which said yesterday that it would sue the British Government over the seizure of Kaupthing’s assets.

The Government’s call to E&Y at the weekend comes as the retail magnate Sir Philip Green seeks ministerial support to help him to buy Baugur, whose assets include House of Fraser, a stake in Debenhams and high street chains, including Whistles and Karen Millen. It is understood that Sir Philip has approached Gordon Brown, Lord Mandelson, the Business Secretary, and Treasury officials to ask them to support his move for Baugur. He wants assurances that if he buys assets from the Icelandic Government he will not have to deal with the International Monetary Fund (IMF) if Iceland, as expected, turns to the IMF to stave off national bankruptcy.

Sources said that Sir Philip and rival bidders for Baugur’s assets - including Alchemy, Permira and TPG - fear that the IMF could try to claw back businesses sold by the Icelandic Government if the country went into default. It is understood that Alan Bloom, an Ernst & Young partner, was asked by the Government to prepare to go into Landsbanki this week as administrator if necessary. Ernst & Young, the Treasury and the Financial Services Authority declined to comment on the standby appointment.

Mr Bloom and his team are already advising on the Kaupthing administration and the administration of Heritable bank, Landsbanki’s UK subsidiary. On Monday the British Government lifted a freezing order on Landsbanki that was preventing all the bank’s corporate clients from drawing down more money on their overdrafts. Sources said the Government feared that restricted cash flow could put some retailers at risk of bankruptcy. It is believed that the Government wants to seize and sell on Landsbanki’s assets to cover the £588 million of local councils’ money deposited in Icelandic banks and now in the hands of the Icelandic Government.

Iceland rushed to stave off economic ruin today by slashing interest rates by 3.5% and pursuing talks with Russia over the possibility of a multibillion euro loan. But despite the cut, which brought the policy rate down from a record high of 15.5%, the central bank issued a bleak forecast, predicting the collapse of Iceland's banks would be "extremely burdensome" and the economic contraction "very sharp".

In a statement warning of numerous job losses and reduced market demand, the bank noted: "The Icelandic economy has been subjected to unprecedented turbulence in the past few weeks. The banking system has not been able to withstand the trials it has faced as a result of difficult market conditions, global deterioration of confidence in economic affairs, and domestic risk appetite. "A variety of jobs have disappeared virtually in the blink of an eye, demand has declined precipitously and, by all measures, expectations are at a low ebb."

As the team of Icelandic officials sat down with their Russian counterparts for a second day of bail-out negotiations in Moscow, the country drew on swap facilities with Denmark and Norway, tapping them each for €200m (£155m) to kickstart its currency markets. The country has already accepted a £100m loan from the UK government to help it repay depositors in Landsbanki, one of the three Icelandic banks nationalised last week after the country's banking system fell apart.

Iceland is also due to present a plan to the International Monetary Fund over the next few days and is widely expected to seek funds further afield. The country has endured years of high interest rates as its central bank struggled to control inflation. A collapse of the Icelandic krona exacerbated the situation as the island nation is heavily dependent on imported goods.

Asgeir Jonsson, an analyst at Kaupthing, which was nationalised along with Landsbanki and Glitnir last week, welcomed the interest rate cut. "It will help companies that will now have to be financed by Icelandic banks," he said. "Going forward, we will not see any serious inflation in 2009 given that 20% of the CPI [consumer price index] is the housing market. Labour unions have said they would be willing to accept a two-year wage freeze. "The main thing is that they have to stabilise the currency and get the payments system going again."

The Icelandic prime minister, Geir Haarde, insisted he still had "full confidence" in the head of the central bank, David Oddsson, even though the governor has been criticised by some for his handling of the crisis. "This is not the time to assess blame for what happened; this is the time to find solutions," said Haarde. While Iceland tried to shore up its economy, the British government announced it had sent emergency teams into three of the 116 local councils that have a total of £858m deposited in Icelandic banks.

Thirteen local authorities said they may face short-term problems because of the blocked deposits, but ministers stressed there was "no reason to think that wages will not be paid or that services could be at risk". After talks this afternoon, the government and the Local Government Association released a joint statement saying they were working "to get the best and most rapid resolution of the situation relating to Icelandic banks and the £858m".

Meanwhile, speculation mounted over the future of the Icelandic retail investor Baugur, whose UK interests include Hamley's, House of Fraser, Karen Millen and Oasis. Although the British retail magnate Sir Philip Green had been regarded as the favourite to snap up Baugur's £1bn debt — and possibly its entire operation — reports suggestt other potential buyers have emerged, among them the equity groups TPG, Permira and Alchemy. TPG and Permira declined to comment, while Alchemy was not available to comment.

However, Green, whose high street empire includes Bhs and Topshop, said a deal was still being put together. Green, who flew to Reykjavik yesterday, added: "I need to do some more work." On Tuesday, Baugur dismissed reports that it had appointed advisors said it had not plans to put its UK business into administration.

"Nothing is moving because the trader doesn't want to take the risk of putting cargo on the boat and finding that nobody can pay." The lack of letters of credit, in which banks guarantee payment for merchandise, could become a "big issue" for world trade, according to Klaus Nyborg, Deputy Chief Executive Officer at Pacific Basin. Tighter credit has contributed to this year's 80 percent drop in the Baltic Dry Index, a measure of commodity-shipping costs. About 90 percent of world trade moves by sea.

"This can have a significant effect on demand because you won't see the same volume of cargo moved," Harold L. Malone III, senior vice president at Jefferies & Co., said at a Marine Money conference in Singapore. "You have to figure out other ways to get trade done." The Baltic Dry Index dropped 8.5 percent to 1,809 points yesterday, the lowest since August 2005. Pacific Basin dropped 6.5 percent to HK$4.75 in Hong Kong and Precious Shipping declined 5.5 percent to 12.1 baht in Bangkok.

Banks worldwide have curbed lending because of increased concerns about getting their money back. Shipowners are already struggling to obtain funding for new vessels. Precious Shipping took as long as 15 months to secure financing for 18 vessels it has on order, Hashim said. The maritime sector needs about $300 billion over the next three to four years to fund construction of vessels that are already on order, according to Nordea Bank Finland Plc.

At least a quarter of container ships, dry-bulk vessels and oil tankers on order are not financed, according to Seaspan Corp., the Hong Kong-based ship lessor. Swings in the London interbank offered rate, which lenders typically use as a base for writing new loans, have made it difficult to decide what price to charge new customers. "The banks cannot fund at Libor rates at the moment," said Keishi Iwamoto, head of shipping for Asia at Sumitomo Mitsui Banking Corp. "The question is how do we tackle the additional costs for lenders."

German banks with funds to lend are offering about 200 basis points above Libor, double previous rates, while in Singapore the rate is plus-350 points, according to Tobias Koenig, managing partner of Koenig & Cie. In the main though, shipping lines aren't able to borrow, he added. "There is no rate because all banks are closed for business," he said. "You have a few banks rescuing their best customers, but that's it." More than two-thirds of 104 bankers polled said they were unable to obtain funding at or close to Libor, according to an October survey by trade publication Marine Money Asia.

About 80 percent expect shipping bankers will not be able to raise enough financing for clients this year and next, the survey showed. "There are a lot of banks that will do deals today but they will do it on a bilateral basis with good clients, which they have long relationships with," Tom Zachariassen, an executive at Nordea Bank, said yesterday. Libor, set by 16 banks in a survey conducted by the British Bankers' Association each day in London, determines rates on $360 trillion of financial products worldwide, from home loans to derivatives. The cost of borrowing in dollars for three months fell 12 basis points to 4.64 percent yesterday.

Citigroup, the world's biggest bank by revenue, reported a fourth consecutive quarterly loss after recording a further hit from the credit crunch of at least $13 billion (£7.5 billion). The group reported a loss of $2.8 billion for the third quarter, down from a $2.2 billion profit the year before. However, the loss was smaller than the consensus analyst forecast of $3.8 billion.

Group revenues fell 23 per cent to $16.7 billion. Citigroup, which also said it cut about 11,000 positions during the third quarter, wrote down $4.4 billion in investments, recorded $4.9 billion in credit losses and took a $3.9 billion charge to boost reserves. Vikram Pandit, Citigroup’s chief executive, said: “While our third quarter results reflect both a difficult environment as well as continued writedowns on our legacy assets, we are making excellent progress on the parts of our business we control, including expense reduction, headcount, and balance sheet and capital management.”

“We expect these improvements will enable us to realise the full earnings power of our franchise as the economy stabilises,” he added.It emerged this week that Citigroup is set to receive $25 billion from the US Government as part of its programme to inject $250 billion into America’s banks in return for equity stakes. Citigroup is the third major US bank this week to report better-than-expected third quarter results.

Yesterday, JPMorgan Chase reported an 84 per cent decline in third quarter profits, to $527 million, as bad mortgages inherited through its acquisition of failed bank Bear Stearns took their toll. But the profit equates to 11 cents a share and compares favourably with the 18 cents-a-share loss that analysts had predicted. Wells Fargo reported yesterday that its profits fell by 25 per cent to $1.64 billion for the third quarter as a $2.5 billion provision for credit losses dragged down the bottom line. It too came in ahead of analysts' expectations.

Bank of New York Mellon Corp., the world's largest custodian of financial assets, said third- quarter earnings fell 53 percent because of costs to prop up 10 money funds hurt by losses on Lehman Brothers Holdings Inc. Net income fell to $303 million, or 26 cents a share, from $640 million, or 56 cents, a year earlier, the New York-based company said today in a statement. Profit excluding some costs was 72 cents a share, topping the average estimate of 69 cents a share of 11 analysts in a Bloomberg survey.

BNY Mellon said last month it would spend $433 million to absorb losses for investors in six institutional funds and four mutual funds that held debt issued by bankrupt Lehman. While the global credit crisis reduced custody and fund-management assets, revenue rose 8.1 percent to $3.9 billion on a record $385 million in fees from foreign exchange and trading. "Their revenue is mixed, with some positive and some negative developments," Michael Kon, an analyst at Morningstar Inc. in Chicago, said in an interview before results were released.

BNY Mellon said this week it will receive a $3 billion equity investment from the U.S. Treasury. It was one of nine companies selected Oct. 14 in the first phase of the government's $250 billion program to inject capital into financial institutions in an effort to unfreeze credit. The government will purchase BNY Mellon preferred stock and warrants. Participating companies must abide by restrictions on dividend payments and executive compensation. The assets BNY Mellon invests for mutual funds, institutions and wealthy individuals fell 3.6 percent to $1.07 trillion. Money-management fees dropped 7.3 percent to $792 million.

Assets for which BNY Mellon provides record-keeping and other custody services decreased 1.4 percent to $22.4 trillion. Securities losses totaled $162 million, up from $152 million in the second quarter. Unrealized losses on the bank's investment portfolio rose 56 percent in the quarter to $2.8 billion. BNY Mellon was chosen two days ago to administer the U.S. Treasury's purchases of toxic securities from financial institutions, part of a $700 billion rescue package. BNY Mellon beat out rivals JPMorgan Chase & Co., State Street Corp. and Northern Trust Corp. for the three-year Treasury contract. The bank will provide custody, accounting and other services for the program. Financial terms haven't been disclosed.

Merrill Lynch & Co reported a third-quarter net loss of $7.5 billion on Thursday -- worse than analysts had expected -- on write-downs and credit losses on complex debt securities. But shares of the brokerage house, which last month accepted a takeover bid from Bank of America Corp, climbed 4 percent on confidence that the merger -- which valued Merrill at $50 billion when it was announced last month -- will still go through.

"There's a lot of moving parts here but none of it is very surprising," said Tim Ghriskey, chief investment officer at Solaris Asset Management, which owns no shares in either Merrill or Bank of America. Merrill posted more than $9 billion in write-downs and credit losses, most of which occurred in September. It cited the bankruptcy of Lehman Brothers Holdings Inc and wide market volatility as driving the losses.

The bank said it would issue $10 billion of non-voting preferred stock and related warrants to the U.S. Treasury under the government program that gave Bank of America a $25 billion capital injection earlier this week. In addition, because of the Bank of America deal, Merrill said it was no longer seeking to sell a controlling stake in its Financial Data Services subsidiary.

Merrill had said when it announced second-quarter results that it had signed a letter of intent to sell FDS, which provides administrative services to the company's mutual funds and retail banking businesses. The bank did receive a pretax gain of $4.3 billion from the sale of its 20 percent stake in Bloomberg, the media and data company, which had also been announced with its second-quarter results.

Merrill, like former peers Lehman Brothers and Bear Stearns Cos, has struggled to survive the credit crisis, which has crippled its large mortgage and complex debt businesses. In July, Merrill sold a $30.6 billion portfolio of structured debt securities to private equity firm Lone Star Funds, taking a $5.7 billion write-down and raising capital in the process -- but this was not enough to solve its problems. The company's share price continued to fall, and Chief Executive John Thain engineered the speedy sale to Bank of America on the same weekend that Lehman Brothers was forced into bankruptcy.

There had been doubts about the deal going through, and the difference between Merrill's share price and the price implied by the deal was initially wide. But the difference has been narrowing in recent weeks. Merrill shares were at $19.00 -- about 10 percent below the price implied by the deal -- in early trading on the New York Stock Exchange. The shares had been as much as 35 percent below the deal price. "Certainly, this acquisition should be a concern to Bank of America shareholders, but we believe that Bank of America is acquiring these assets at a bargain-basement price," said Ghriskey.

On a conference call with analysts Thursday morning, Thain said he expected the shareholder vote on the deal to be held in mid- to late November. Merrill said its third-quarter net loss applicable to common shareholders widened to $5.58 per share from $2.82 per share, or $2.3 billion, a year earlier. The company posted a loss of $5.56 per share from continuing operations. Analysts' average forecast was a loss of $5.18 per share, according to Reuters Estimates.

New York Attorney General Andrew Cuomo is investigating "unwarranted and outrageous expenditures" at American International Group Inc., which received an $85 billion federal bailout last month. In a letter to AIG's board of directors, Cuomo demanded the company stop "extravagant" expenditures and recover millions of dollars in unreasonable payments, or face legal action.

Cuomo cited a $5 million bonus and a $15 million "golden parachute" AIG awarded its chief executive officer in March. Martin Sullivan was AIG's CEO at the time. Cuomo said the company also spent hundreds of thousands of dollars on "luxurious retreats" for executives, including an overseas hunting party and a golf outing. "The party is over," Cuomo said today at a press conference on Wall Street in lower Manhattan. "No more hunting trips. No more luxury resorts. They are not going to have the party and leave the hangover for the taxpayers."

AIG has been castigated by officials since the New York- based insurer hosted a $440,000 conference at a California resort last month after agreeing to the federal bailout to avoid bankruptcy. In a letter released Oct. 10, House Financial Services Committee Chairman Barney Frank told Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke the executives responsible for the gathering should "personally reimburse the government," and requested increased oversight of the company. Frank asked for a response by the end of this week.

Cuomo claimed in his letter that the expenditures violated the state's debtor-creditor law and demanded an accounting of AIG's executive compensation and benefits since January 2007. He said the government's financial rescue of AIG made the expenditures "even more irresponsible and damaging." The U.S. government offered AIG an $85 billion loan last month as the company slipped toward insolvency. The company may access an additional $37.8 billion from the Federal Reserve Bank of New York to replenish liquidity.

Cuomo's letter "will be brought to the immediate attention"' of AIG directors, said Nicholas Ashooh, a spokesman for the insurer."The events referred to should have been canceled, it's regrettable they weren't, but we've issued a policy canceling all such events and reviewing all expenses going forward," Ashooh said in a phone interview. He declined to comment on Sullivan's compensation. The hunting trip to the English countryside, an annual event for customers and executives, cost $86,000, the Associated Press reported.

AIG fell 37 cents, or 13 percent, to $2.43 in New York Stock Exchange composite trading. The shares have slumped 96 percent this year. AIG said today in a statement it would "fully cooperate" with Cuomo's office. "AIG's priority is to continue focusing on actions necessary to repay the Federal Reserve loan and emerge as a vital, ongoing business," according to the statement. Cuomo also noted in his letter that an unnamed top-ranking executive, "who was largely responsible for AIG's collapse" and was fired in February, was allowed to keep $34 million in bonuses. Cuomo said the executive also apparently continued to receive a $1 million a month from the company until recently.

Joseph Cassano was head of AIG's financial-products unit until his retirement was announced Feb. 29. The business sold credit-default swaps, the contracts that plunged in value as the mortgage securities they guaranteed declined, causing more than $25 billion in writedowns at AIG. A Cuomo case against former AIG Chief Executive Maurice "Hank" Greenberg, over an alleged multibillion fraud at the company, is pending in New York state court. Cuomo wouldn't comment today on that case, or on whether Greenberg deserves any blame for AIG's condition.

Greenberg, invoking his Fifth Amendment right against self- incrimination, refused to answer Cuomo's questions on Oct. 11, Fortune reported today. Greenberg's lawyer, Robert Morvillo, didn't immediately return a call from Bloomberg News seeking comment after business hours. Robert Willumstad, who replaced Sullivan as AIG CEO until the government takeover ended his three-month tenure, said today it would be "pretty tough" to recover compensation from former employees. "They got paid based on an agreement between the company," Willumstad said on CNBC. "It's pretty hard to go back and ask them to give back money they presumably earned fairly at the time."

Federal investigators have opened an investigation into the collapse of Washington Mutual Inc, the largest U.S. banking failure. Jeffrey Sullivan, U.S. attorney for the western district of Washington, said in a statement on Wednesday that he has set up a task force that includes investigators from the FBI, the U.S. Securities and Exchange Commission, the Federal Deposit Insurance Corp and the Internal Revenue Service's criminal investigations unit.

"Given the significant losses to investors, employees and our community, it is fully appropriate that we scrutinize the activities of the bank, its leaders and others to determine if any federal laws were violated," Sullivan said in a statement. He said the probe comes on the heels of "intense public interest in the failure of Washington Mutual." Federal regulators seized Seattle-based Washington Mutual on Sept 25 after the savings and loan, once the nation's largest, had $16.7 billion of deposit outflows in 10 days.

JPMorgan Chase & Co bought the Seattle-based thrift's banking units on that date for $1.9 billion, in a transaction arranged by regulators. Washington Mutual later filed for Chapter 11 bankruptcy protection from creditors. Washington Mutual collapsed amid soaring losses from mortgages and home equity loans, and less than three weeks after replacing its longtime chief executive, Kerry Killinger.

The Office of Thrift Supervision, which regulated the thrift, said on Sept 25 that Washington Mutual did not have enough liquidity to pay its debts, and was in an "unsafe and unsound condition to transact business." Regulators said the thrift had about $307 billion of assets, more than seven times the $40 billion that Continental Illinois National Bank & Trust had when it collapsed in 1984, in the nation's largest previous banking failure.

The dust had barely settled on Tuesday's Canadian election when economists and a prominent business group said the newly returned Conservative government may need to adjust course to avert a possible budget deficit next year. The Canadian Chamber of Commerce urged Prime Minister Stephen Harper on Wednesday to give a fiscal update as soon as possible because the global economic outlook has worsened in recent weeks.

Harper said in Calgary, Alberta, that he plans to summon politicians back to work this autumn and will present an economic and fiscal update before the end of November. "The sooner it can be done, the better, because clearly economic conditions have changed substantially since the budget in the spring," Chamber of Commerce President Perrin Beatty told Reuters.

Commodity prices have slumped and weaker U.S. demand for goods will hurt Canada's export-oriented economy, while the higher cost of credit and financial market volatility will dampen domestic spending, the chamber noted in a letter sent to Harper. "The ability of the government to meet its commitments may be compromised by an economy that will show little or no growth over the next year, constraining government revenues," the chamber said.

"The affordability and timing of commitments will need to be reexamined to avoid risking a deficit next year." During the election campaign, Finance Minister Jim Flaherty said he expects a budget surplus of at least C$3 billion ($2.5 billion) in the 2008-09 fiscal year. While the government should be able to eke out a small fiscal surplus in the current year, its plan for a surplus next year "is at serious risk," Dale Orr, chief Canadian economist at research firm Global Insight, wrote in an article on Wednesday. Orr suggested the government identify spending that can be postponed.

Merrill Lynch Canada chief economist David Wolf agreed that a small surplus looks likely this fiscal year, due to better results in the first half, "but next year looks awful". Wolf's economic forecast is for a deficit of C$10 billion in fiscal 2009-10, "assuming no change in policy". The government could avoid a deficit by raising taxes or cutting spending, but those would put pressure on an already weak economy, Wolf said. "We don't know how the Conservatives will confront the looming fiscal hole, or what the opposition will be willing to support," he wrote.

Craig Wright, chief economist at Royal Bank of Canada, told a business luncheon in Ottawa that his team forecasts neither a Canadian recession nor a budget deficit. But if growth surprises on the weak side, Wright said he would not recommend avoiding a deficit at all costs. "If we were to be pushed into a deficit because the economy is weak, I wouldn't think we should panic and try to fight that off (by raising taxes) at the cost of more significant downturn to the economy," Wright said.

Their musings about fiscal pressures come as the Canadian government considers how to keep the country's financial system stable and competitive while governments elsewhere are propping up their weaker banking sectors. Ottawa should consider several actions on top of measures already taken to ease effects of the credit crisis, the Chamber of Commerce said in its letter.

The Bank of Canada should provide further short-term interest rate relief by cutting its overnight rate by half a percentage point on Oct. 21, its next scheduled announcement date, the chamber said. Other measures could include creating a commercial paper and bankers' acceptances funding facility, as the U.S. Federal Reserve has done, and insuring all bank deposits, regardless of size, "to boost confidence and remain competitive," it said.

Investors pulled at least $43bn from US hedge funds in September as market turmoil led to unprecedented withdrawals, an analysis by a leading research house shows. The data from TrimTabs Investment Research – which was to be sent to clients late on Wednesday – come as hedge funds are working to prevent far bigger redemptions by the end of the year, when many funds give investors a chance to take out money.

Withdrawals can lead to a vicious circle in the markets, as funds sell holdings to return money to clients, depressing prices and prompting further redemptions. To prevent such an outcome, some hedge funds had offered to suspend fees if investors kept their money in until March, said Marc Freed, of Lyster Watson, which invests in hedge funds on behalf of institutional and private clients. “Every investor fears other investors will pull their money and so they worry they will be at the back of the line if they don’t also pull,” Mr Freed said.

“Nobody will invest in anything illiquid because they think they may not survive long enough to see them rise in value.” A fundraiser for a major hedge fund said the period “between now and December 1 is a sort of death march” for the industry. The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses.

Conrad Gunn, chief operating officer of TrimTabs, said the $43bn in September withdrawals would mark “the beginning of what we expect to be a series of outflows for the remainder of the year. We expect October outflows to be larger”. Mr Gunn said the September outflows were based on an analysis of preliminary data and that the final tally would probably be higher because funds with heavy redemptions tended to report data later. The industry, which manages close to $2,000bn, has experienced outflows during only a handful of months previously, including a small outflow in April of this year.

JPMorgan Chase has estimated that hedge fund outflows could total up to $150bn over the coming year. As investors take their money out of hedge funds, the funds have to sell assets. But because they use so much borrowed money, the amount of potential asset sales is far larger. For example, JPMorgan expects that an outflow of $150bn will lead to sales of about $400bn.

The head of one of America's biggest hedge fund industry groups has written to Mervyn King, Governor of the Bank of England, warning that a failure to free up an estimated $70 billion in assets frozen in Lehman Brothers' could trigger "systemic" losses.Richard Baker, the head of the US Managed Funds Association (MFA), has warned delays could be “disastrous for UK plc”.

The plea comes on the eve of a meeting between the administrators of Lehman Brothers International (Europe) and regulators. The former Congressman believes that the handling of the wind-up of Lehman Brothers and the carving up of its remaining assets is adding new uncertainty to already panicky global markets and releasing the bank's securities would give the market “a much needed boost of liquidity and confidence.”

In the letter, dated October 13, Mr Baker said: “Prime brokerages are already withdrawing their assets from the UK prime brokers."The MFA estimates assets held by Lehman Brothers International under prime brokerage accounts to be between $40 billion and $70 billion across 1,300 accounts.

In the letter, Mr Baker urged the Bank to work with the Financial Service Authority and the Treasury to stop making European administrators liable for any wrongful move to distribute the assets to clients. The plea by the MFA marks the latest in the saga of the collapse of Lehman Brothers, which went bust last month. Even though, the US Treasury Secretary, Henry Paulson, had tried to devise a rescue plan for the struggling Wall Street bank, it was allowed to fail.

An unprecedented cash crunch is choking the ability of banks to lend and creating an opportunity for hedge funds to launch, or ramp up corporate lending facilities. Companies that have relied on bank borrowing to grow, or even maintain their business, are turning to hedge funds in a move that some say may signal a broad shift of lending from banks to asset managers.

"I have a very strong belief that the new investment banks will be the absolute return hedge funds and the managers of private equity," said Thomas Priore, Chief Executive at ICP Capital, an investment firm that manages $13 billion in fixed income assets, in New York. "They're not going to become banks, they're going to provide the functionality and interface with people looking for capital, like the investment banks used to, but with an asset management balance sheet approach," he added.

ICP began lending directly to companies earlier this year, focusing on making loans that are secured against cash flows. Most recently, the company arranged a $121 million financing package for the purchase of two ships that will be leased to a unit of Mexican state-owned oil company Petroleos Mexicanos, or Pemex. "The capital constraints on banks are opening up opportunities for new entrants, like our firm, who can take leveraged credit assets and loans from bank balance sheets," Priore said. "Banks, and other companies, will not be afforded the leverage they once were," he added.

Banks have been scrambling for capital to offset losses from bad mortgages and other investments at the same time as both credit and stock investors have been hesitant to back the companies. The U.S. government has scrambled for ways to shore up the sector, including a plan to pump $250 billion into institutions in exchange for equity stakes. Even when the financial sector does finally stabilize, however, banks ability to lend will remain constrained relative to recent years.

General Motors Corp, First Data Corp, AMR Corp and Goodyear Tire & Rubber Co were among a number of companies that tapped their credit lines last month, as credit markets froze and in some cases on fears that if they waited the capital may no longer be available. And the more companies that tap their credit lines, the more pressure it puts on bank balance sheet. "Banks are already balance sheet-constrained and they're getting tapped, so it causes even tighter credit," said Greg Peters, chief U.S. credit strategist at Morgan Stanley in New York.

"What you're seeing also is secondary transactions occur where banks will sell out unfunded revolvers at a discount so they don't have to clog up their balance sheet," Peters said. Standard & Poor's said on Tuesday than anticipate more high yield companies will need to draw on the credit facilities as long as lending remains strained. "We expect firms will tap any prearranged credit lines or turn to private capital until conditions improve," analyst Diane Vazza said in a report.

NIR Group, an alternative investment firm that oversees $7 billion in investments and has been directly lending to small- and mid-sized companies for 10 years, now sees enhanced opportunity to expand the business, said Corey Ribotsky, Managing Member of the firm in Roslyn, New York. "Alternative investment vehicles are going to replace banks and investment banks as being the only financing source for a lot of companies, small, medium and large," he said. "That field has increased tenfold as traditional investment banks and traditional banks have not been able to lend to these companies at all."

As opportunities increase Ribotsky sees the potential to work with larger companies than it has traditionally lent to, as well as enter into more deals. "We're seeing an increase in the number of companies looking for capital and the ways in which they're going to be looking for it," he said. While asset managers look poised to take over much of the business of traditional banks, the way in which lending is done may take different forms. "To a large degree, I think companies are looking for a business partner," said ICP's Priore.

"Investment banks in the past have really been syndicators of risk, not principal risk takers," he said. "Companies want financing from organizations that have the banking skills but want to participate in their business as a principal as well."

President George W. Bush said U.S. taxpayers will get back "most" of the federal money spent in an effort to calm financial markets and he's optimistic that the economy will recover. "We're not going to use taxpayers' money to enrich financiers," Bush said today after lunching with local business leaders in Ada, Michigan, a suburb of Grand Rapids.

"It's likely we'll not only get most of the money back, but in some cases actually make a little money," he said. "People aren't going to be able to have a golden parachute as a result of your hard-working money," Bush said, referring to executives' severance payments. U.S. stocks slumped for a second day, hammered by the biggest drop in retail sales in three years and growing doubt that plans to bail out banks will keep a recession at bay.

The Treasury Department is set to inject $250 billion of taxpayer funds into U.S. banks in an effort to end a credit freeze that threatens to bankrupt businesses and spur layoffs. The rescue is part of a larger $700 billion package and follows a massive stock sell-off last week, the largest since 1933. Michigan has the nation's highest jobless rate at 8.9 percent, having shed 40,000 factory positions in the past year, according to the federal Bureau of Labor Statistics.

U.S. auto sales could see one the slowest sales months in a quarter-century, according to a Deutsche Bank AG forecast for October.Bush signed a bill Sept. 30 that offers the auto industry $25 billion in low-interest federal loans. Detroit-based General Motors Corp., Dearborn, Michigan-based Ford Motors Co., Auburn Hills-based Chrysler LLC and others said they needed taxpayer help to finance a shift to more fuel-efficient cars.

Bush is in Michigan just two weeks after his would-be successor, Republican Senator John McCain, largely abandoned efforts to win the state. Republican presidential candidates have fared poorly in Michigan, with the state going Democratic in the last four elections.

Bush administration officials, in their last weeks in office, are pushing to rewrite a wide array of federal rules with changes or additions that could block product-safety lawsuits by consumers and states. The administration has written language aimed at pre-empting product-liability litigation into 50 rules governing everything from motorcycle brakes to pain medicine. The latest changes cap a multiyear effort that could be one of the administration's lasting legacies, depending in part on how the underlying principle of pre-emption fares in a case the Supreme Court will hear next month.

This year, lawsuit-protection language has been added to 10 new regulations, including one issued Oct. 8 at the Department of Transportation that limits the number of seatbelts car makers can be forced to install and prohibits suits by injured passengers who didn't get to wear one. These new rules can't quickly be undone by order of the next president. Federal rules usually must go through lengthy review processes before they are changed. Rulemaking at the Food and Drug Administration, where most of the new pre-emption rules have appeared, can take a year or more.

The Bush administration's efforts to protect corporations that comply with federal rules from legal action have fueled a long-running power struggle between business interests, which support the efforts, and consumer groups and trial lawyers who have denounced the moves.The U.S. Chamber of Commerce's Institute for Legal Reform supports pre-emption as part of its campaign to "neutralize plaintiff trial lawyers' excessive influence over the legal and political systems," according to its Web site. "It's exceedingly difficult for companies to comply with 50 different state standards," the Institute's president, Lisa Rickard, said in an interview.

The American Association for Justice, the trial lawyers' lobby, is trying to formulate a strategy to undo pre-emptive rules. "This is the gift that keeps on giving for corporations," said the association's chief executive, Jon Haber. The use of rulemaking to protect corporations from product liability was discussed from early in the Bush administration, said former Bush domestic-policy adviser Jay Lefkowitz, who was instrumental in the process.

One administration concern was the spiraling number of multimillion-dollar product-liability lawsuits against corporations based on state "failure to warn" rules, said Mr. Lefkowitz and other former administration officials. Some state consumer-safety laws on product warnings are tougher than, and conflict with, federal standards, particularly in the pharmaceutical area. "You can't ask companies to follow different standards," Mr. Lefkowitz said. The lobby for drug makers, the Pharmaceutical Research and Manufacturers of America, says that such inconsistencies on drug labels "may be, at best, confusing, or at worst, life-threatening."

The Office of Management and Budget, which reviews regulations, has denied there has been a top-down plan in the administration to end lawsuits via regulatory changes. But in March, the OMB directed wording on railroad-tank-car safety. According to an email titled, "Preemption language for the preamble in the tank car rule," the Federal Railroad Administration and the Pipeline Hazardous Materials Safety Administration, part of the Department of Transportation, were asked to use OMB's pre-emption wording. The rule hasn't been finalized.

Mr. Lefkowitz said the administration decided not to press its pre-emption agenda in Congress, where it might lose. "There was already authority within federal government statutes and regulations to start the reform process without legislation," he said. "Using that and legal briefs, we proceeded."

The FDA began entering lawsuits and submitting briefs on the side of drug makers and supporting federal pre-emption in 2001, though the agency previously supported the right to sue. The Supreme Court will hear arguments next month in a case called Wyeth v. Levine that will be a big test of federal pre-emption authority. Diana Levine, a musician, lost an arm to gangrene after receiving an antimigraine drug made by Wyeth in a hospital emergency room. She claims the company didn't adequately warn about side effects under Vermont law. Wyeth says it followed federal warning-label standards and is protected from Ms. Levine's claims.

The FDA, through the Justice Department, is defending pre-emption in that case, citing its own 2006 rule that says federal safety regulations trump state ones. Pre-emption regulations are already affecting some pharmaceutical suits. The state of Alaska recently settled a case with Eli Lilly & Co. to recoup medical costs for the antipsychotic drug Zyprexa for $15 million, a fraction of the original amount demanded, because of the Wyeth case, which could undo a large jury verdict, said the state's assistant attorney general Ed Sniffen.

Leigh Sogoloff, who spends her evenings lap-dancing at Rick's Cabaret Vegas on Procyon Street, says she's making half her income of a year ago. "You don't shop, you don't buy stuff you can't afford," the 36-year-old Sogoloff said between dances at the Las Vegas club. She has postponed buying a house and is reading Deepak Chopra. "I know how to save money. I'm not a dumb stripper."

The city that sold Americans on the dream they could lay down a small wager and walk away millionaires is reeling from speculation in the housing market that helped bring down Wall Street. The quick profits that so easily spread from Nevada to Florida, just as casino gambling migrated to 37 states, are now proving what happens in Vegas rarely stays in Vegas. Las Vegas leads the nation in falling home prices, foreclosures and stalled construction projects. Rick's Cabaret International Inc., with 20 clubs in seven states and two in Buenos Aires, has lost 74 percent of its market value this year.

The "main nerve" of the American dream runs through this desert metropolis, Hunter S. Thompson concluded in his 1971 book, "Fear and Loathing in Las Vegas." Chopra, the spiritual teacher whose writings Sogoloff has turned to, said that less than 2 percent of the $3 trillion to $4 trillion that circulates in the world's markets daily is used for goods and services. "The rest is trying to make money off money," said Chopra, adjunct professor at Northwestern University's Kellogg School of Management in Evanston, Illinois. "Our financial structure which, of course, is an American system but is now global, is pure speculation. It's gambling."

More than $10 billion of hotel and casino projects with 10,000 rooms have been delayed on Las Vegas Boulevard, better known the world over as the Strip, according to locally based real estate and economic consulting firm Applied Analysis LLC. Gaming revenue for casinos on the Strip fell for the eighth straight month in August from a year earlier, the longest streak of declines since records began in 1983, according to the Nevada Gaming Control Board in Carson City. The 16 percent drop in May was a record. August revenue fell 7.4 percent. "The only comparable period was around 9/11, when we were down for five straight months," Frank Streshley, senior analyst at the board, said in an interview. "This is a very difficult time for the gaming industry."

All this in a state that led the U.S. housing boom with an estimated 275,000 new homes built from 2000 to 2007, a 33 percent increase that was the highest of any state, according to the Census Bureau. Now, many of those homes are empty and worth less than when they were built. The bust that started almost three years ago has brought down New York-based securities firm Lehman Brothers Holdings Inc. and led to the forced sales of investment banks Bear Stearns Cos. and Merrill Lynch & Co., and led to more than 137,000 job losses in financial services worldwide.

Las Vegas had the biggest home-price decline in the country in July and Nevada had the highest foreclosure rate in August. One in 91 homes in Nevada were in some stage of default, compared with one in 416 for the U.S. overall. California had the second-highest rate and the most foreclosure filings, and Florida had the second- most filings. The signs of decline are right on the Strip, where Boyd Gaming Corp.'s $4.75 billion Echelon casino and resort may be the most obvious symbol for the city's economic slowdown.

Boyd said on Aug. 1 it would halt construction of the Echelon, a 5,000-room property with five hotel towers, after investing $500 million. The company broke ground on the 87-acre development, on the site of the demolished Stardust hotel at the northern end of the Strip, in June 2007, just before the onset of the global credit crunch. Construction equipment, including two excavators and one backhoe, sat idle last week. Six tower cranes stood poised over the project's steel skeleton, which was halted at the ninth story. The tallest tower is to be 58 stories. The cranes may stay there until building resumes, said Ryan McPhee, a Las Vegas developer who monitors construction in town.

"With things slowing down, there may not be the demand" for the equipment, McPhee said. "There's almost no way to get financing for projects right now." Boyd will delay Echelon for "three or four quarters, assuming the economy turns and credit markets open up," said spokesman Rob Stillwell. "When a home-grown leader like Boyd builds a mega-resort framework, then suddenly says they're halting the project, that's a stunner," said George McCabe of B&P Advertising and Public Relations, which creates ad campaigns for Las Vegas's real estate industry. "It's scary."

A relative bright spot on the Strip may be CityCenter, an $11.2 billion joint venture between MGM Mirage, the world's second largest casino operator, and Dubai World, a holding company for the government of Dubai. About 60 percent of the development's 2,647 luxury condominium and hotel-condo units are under contract, with $350 million in non-refundable deposits. "Our product is different and we're selling real estate for future delivery," said Tony Dennis, executive vice president.

At Las Vegas's McCarran International Airport, the total number of arriving and departing passengers in August dropped 9.9 percent from a year earlier, when a record 4.3 million passengers went through the airport. Highway traffic declined 4.9 percent through July, the latest month for which figures are available, the visitors authority said. "We are uniquely positioned to be penalized by the global slowdown, because we're hugely dependent on the consumer getting in a car or plane to get away from their lives," said Jeremy Aguero, co-owner of Applied Analysis.

Southwest Airlines Co., which has more flights leaving Las Vegas than any other city, had a 7.3 percent drop in Las Vegas passengers in August, and starting in January the Dallas-based carrier will cut its daily Las Vegas departures to 227 from 240. Occupancy at Las Vegas hotels fell 2.4 percent and the average daily room rate dropped 6.6 percent in the seven months through July compared with a year earlier, according to the Las Vegas Convention and Visitors Authority. In July alone, the latest month for which numbers are available, room rates were down 10 percent.

The unemployment rate for the Las Vegas metropolitan area rose to 7.1 percent in August, a 2.1 percentage point increase from a year earlier. Those numbers don't tell the story of people such as Dimi Doronis, a banquet server for Aramark Corp. Doronis worked just four days in July, six in August and 10 last month catering at conventions, down from about 25 days per month a year ago. She doesn't get paid when she's not given a catering assignment, and the Bulgarian native spends her days reading books about Eastern European politics. "I've been 18 years in this town, and I've never seen what's gone on like it has this last month," the 44-year-old Doronis said. "I don't know how I'm still alive. I'm digging into my savings right now, but soon it's going to be done."

Mark Stubbins, a cab driver in Las Vegas for two and a half years, watched his tips drop to as low as $30 a day from as much as $80 a day before business started slowing down in May. The 53- year-old said he's struggling to meet his company's daily fare goals, which were set a year ago, when more tourists and businesspeople were still coming to town. "You can't do what's not there," he said. Sogoloff, the stripper from Rick's Cabaret, said she moved to Las Vegas in 1999 because "I knew it was good out here." She's put her plans to buy a house on hold while she watches her money. "That's why I don't own a home right now."

Las Vegas's housing market is the worst in the U.S. Home values in the area at the end of the second quarter had fallen to March 2004 levels, according to the S&P/Case-Shiller Home-Price Index. Las Vegas prices fell 30 percent in July from a year earlier, the biggest drop among 20 U.S. metropolitan areas. The median price in August was $210,000, and three out of four home sales were bank-owned properties that were foreclosures, the Greater Las Vegas Association of Realtors said. Nevada's foreclosure rate was the highest of any state for the 20th straight month in August, according to RealtyTrac Inc.

Hotels are using new promotions to try to win budget- conscious visitors. Harrah's Entertainment Inc., the world's largest casino company by revenue, offered a "Two Cent Tuesday" deal this month at its Harrah's Las Vegas property. The promotion allows guests to stay for that price as long as they book two nights before or after Tuesday at the regular rate, said spokeswoman Suzanne Trout. At the 1.9 million-square-foot Las Vegas Convention Center, visitor volume declined 1.1 percent this year through July, and attendance at some retail and merchandising events fell, according to the visitors authority. The MAGIC apparel convention was cut to three days in August from four days a year earlier.

Gambling was legalized in Las Vegas in 1931, the same year work began on the Hoover Dam. Mobster Benjamin "Bugsy" Siegel, a member of the Meyer Lansky crime organization, popularized Las Vegas in 1946 when he opened a hotel named The Flamingo, the nickname of his girlfriend, dancer Virginia Hill. Since then, the city has become the destination of millions, who come for the shows, the gambling tables or just to sit bleary- eyed in front of the slot machines, pumping in coin after coin, "still humping the American Dream, that vision of the Big Winner somehow emerging from the last-minute pre-dawn chaos of a stale Vegas casino," as Thompson wrote in "Fear and Loathing."

Some also come for entertainment that justifies the Vegas slogan, "What happens here, stays here." Rick's Cabaret Vegas was known as Scores Las Vegas until Houston-based Rick's bought the club last month. A dancer whose stage name is Louanna who works with Sogoloff said she made $6,000 performing in September, down from $8,000 a year ago and $30,000 in January 2007, her best month in the two and a half years she's been performing.

Vegas workers may see their pay continue to shrink as tourists, turned off by the casino-style wagers they placed on their homes and retirement funds, stay away, said Faith Popcorn, who tracks cultural trends and spending habits as chairman of New York-based Faith Popcorn's BrainReserve. "When we talk about gambling, that's a word we don't want in our vocabulary."

Ilargi: Wait a minute London Times... there’s a few people missing here!

The financial events of recent weeks have filled many of us with shock and panic. Surely no one could have predicted that we would be in this mess? Well, actually, they did. Here are ten people who saw the financial meltdown coming...

1. Vince Cable - deputy leader of the Liberal DemocratsHere is a question Mr Cable’s posed to Gordon Brown, then Chancellor, during Treasury Questions back in November 2003: “The growth of the British economy is sustained by consumer spending pinned against record levels of personal debt, which is secured, if at all, against house prices that the Bank of England describes as well above equilibrium level. What action will the Chancellor take on the problem of consumer debt?”

Mr Brown did not answer how he would solve the problem, merely replying that: “We have been right about the prospects for growth in the British economy, and the hon. Gentleman (Mr. Cable) has been wrong.”

2. Christopher Wood – chief strategist of CLSA, a broking firm in the Asia-Pacific Market.In October 2005 Mr Wood wisely declared: "Investors should sell all exposure to the American mortgage securities market." In an interview in 2007, he said: "Some institutions have been behaving like leveraged speculators rather than banks… The UK economy is heading for a sharp shock. It just remains to be seen how bad."

3. Founders of www.stock-market-crash.net – website aimed at investorsThe writers of this site claim that predicting crashes is, in fact, easy: “One of the greatest myths of all time is that market crashes are random, unpredictable events. The lead up to a market crash is often years in the making. Certain warning signs exist, which characterize the end of a bull market and the start of a bear market. By learning these common warning signs, you can liquidate your investments and prosper by shorting the market.”

4. Henry Weingarten - astrologerMr Weingarten is head of the Astrologers Fund, a New York firm that advises businesses on the basis of planetary movements. He forecast a major economic downturn in March 2007 – so hopefully his clients took note.His website claims he has in fact made numerous successful predictions about worldwide financial affairs, including “both Mexican 1995 crises, the first 1995 dollar crisis, the 1998 oil collapse and 1999 recovery, and the decline of the Euro after its 1999 birth.”

5. Nouriel Roubini - economics professorAka Dr Doom, Dr Roubini is an economics professor at New York University. On September 7, 2006, at an International Monetary Fund meeting, he announced that a crisis was brewing. He said that the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession.

Homeowners would default on mortgages, trillions of dollars of mortgage-backed securities would unravel worldwide and the global financial system would shudder to a halt. These developments, he said, would cripple major financial institutions like Fannie Mae and Freddie Mac.As Mr Roubini stepped down, his host said: “I think perhaps we will need a stiff drink after that.” They do now.

6. Nikolai Kondratiev - Russian Marxist economistIn the early 1920s, Mr Kondratiev proposed a theory that Western capitalist economies have long term (50 to 60 years) cycles of boom followed by depression. These business cycles are now called "Kondratiev waves", or grand supercycles. He predicted an imminent dip, and he was proved right with the Wall Street Crash in 1929. The current crisis may mean he is about 10 years out – but, still, not a bad prediction for a man who died in 1938.

7. Founders of Housepricecrash.co.uk – property websiteHousePriceCrash.co.uk was established in October 2003 after its founders predicted “one of the potentially biggest economic boom bust events in living memory” was coming. Its aim, apparently, is to provide a “counterbalance to the huge amounts of positive spin the housing market receives in the main media”. Whilst there is not currently a lot of positive news about the housing market to counter, the site does provide a plethora of information, statistics and forums for those interested in the great house price crash.

8. Lord Oakeshott - Liberal Democrat Treasury spokesmanHe may not have predicted the entire financial meltdown, but he did warn the Government of the possible collapse of Icelandic banks back in July. He said last week: “"Alarm bells were ringing all over about the Icelandic banks and the Treasury must have been blind and deaf not to hear them."

In a written question to the government in July, he asked: "What steps [have] the United Kingdom financial authorities taken to satisfy themselves, independently of the Icelandic financial authorities, of the solvency and stability of Icelandic banks taking deposits in the United Kingdom?” Lord Davies, for the Government, replied that there was no concern about the liquidity or capital base of Icelandic banks operating in the UK.

9. Stephen Roach - senior executive at Morgan StanleyIn November 2004, Mr Roach predicted an “economic Armageddon”, in part due to the record US current account, trade and government deficits. His outlook was largely dismissed at the time. Having being proved right, he recently went on to accuse central banks of being “asleep at the switch” in failing to stop the escalating crisis. “The lack of monetary discipline has become a hallmark of unfettered globalization,” he said.

10. Ron Paul - Republican CongressmanBack in September 2003, Mr Paul told a House Financial Services Committee that: “Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. “This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions.” Of course, if we are going to give Mr Paul credit, than we should also highlight the efforts of Peter Schiff, his economic advisor and long-time economic hawk.

How did the world's markets come to the brink of collapse? Some say regulators failed. Others claim deregulation left them handcuffed. Who's right? Both are. This is the story of how Washington didn't catch up to Wall Street.

A decade ago, long before the financial calamity now sweeping the world, the federal government's economic brain trust heard a clarion warning and declared in unison: You're wrong. The meeting of the President's Working Group on Financial Markets on an April day in 1998 brought together Federal Reserve Chairman Alan Greenspan, Treasury Secretary Robert E. Rubin and Securities and Exchange Commission Chairman Arthur Levitt Jr. -- all Wall Street legends, all opponents to varying degrees of tighter regulation of the financial system that had earned them wealth and power.

Their adversary, although also a member of the Working Group, did not belong to their club. Brooksley E. Born, the 57-year-old head of the Commodity Futures Trading Commission, had earned a reputation as a steely, formidable litigator at a high-powered Washington law firm. She had grown used to being the only woman in a room full of men. She didn't like to be pushed around.

Now, in the Treasury Department's stately, wood-paneled conference room, she was being pushed hard. Greenspan, Rubin and Levitt had reacted with alarm at Born's persistent interest in a fast-growing corner of the financial markets known as derivatives, so called because they derive their value from something else, such as bonds or currency rates. Setting the jargon aside, derivatives are both a cushion and a gamble -- deals that investment companies and banks arrange to manage the risk of their holdings, while trying to turn a profit at the same time.

Unlike the commodity futures regulated by Born's agency, many newer derivatives weren't traded on an exchange, constituting what some traders call the "dark markets." There were now millions of such private contracts, involving many of Wall Street's top firms. But there was no clearinghouse holding collateral to settle a deal gone bad, no transparent records of who was trading what. Born wanted to shine a light into the dark. She had offered no specific oversight plan, but after months of making noise about the dangers that this enormous market posed to the financial system, she now wanted to open a formal discussion about whether to regulate them -- and if so, how.

Greenspan, Rubin and Levitt were determined to derail her effort. Privately, Rubin had expressed concern about derivatives' unruly growth. But he agreed with Greenspan and Levitt that these newer contracts, often called "swaps," weren't exactly futures. Born's agency did not have legal authority to regulate swaps, the three men believed, and her call for a discussion had real-world consequences: It would cast doubt over the legality of trillions of dollars in existing contracts and create uncertainty over how to operate in the market.

At the April meeting, the trio's message was clear: Back off, Born. "You're not going to do anything, right?" Rubin asked her after they had laid out their concerns, according to one participant. Born made no commitment. Some in the room, including Rubin and Greenspan, came away with a sense that she had agreed to cool it, at least until lawyers could confer on the legal issues. But according to her staff, she was neither deterred nor chastened. "Once she took a position, she would defend that position and go down fighting. That's what happened here," said Geoffrey Aronow, a senior CFTC staff member at the time. "When someone pushed her, she was inclined to stand there and push back."

Greenspan and Rubin maintained then, as now, that Born was on the wrong track. Greenspan, who left the Fed job in 2006 after an unprecedented three terms, also insists that regulating derivatives would not have averted the present crisis. Yesterday on Capitol Hill, a Senate committee opened hearings specifically on the role of financial derivatives in exacerbating the current crisis. Another hearing on the issue takes place in the House today. The economic brain trust not only won the argument, it cut off the larger debate. After Born quit in 1999, no one wanted to go where she had already gone, and once the Bush administration arrived in 2001, the push was for less regulation, not more.

Voluntary oversight became the favored approach, and even those were accepted grudgingly by Wall Street, if at all. In private meetings and public speeches, Greenspan also argued a free-market view. Self-regulation, he asserted, would work better than the heavy hand of government: Investors had a natural desire to avoid self-destruction, and that served as the logical and best limit to excessive risk. Besides, derivatives had become a huge U.S. business, and burdensome rules would drive the market overseas.

"We knew it was a big deal [to attempt regulation] but the feeling was that something needed to be done," said Michael Greenberger, Born's director of trading and markets and a witness to the April 1998 standoff at Treasury. "The industry had been fighting regulation for years, and in the meantime, you saw them accumulate a huge amount of stuff and it was already causing dislocations in the economy. The government was being kept blind to it." Rubin, in an interview, said of Born's effort, "I do think it was a deterrent to moving forward. I thought it was counterproductive. If you want to move forward . . . you engage with parties in a constructive way. My recollection was, though I truly do not remember the specifics of the meeting, this was done in a more strident way."

Rarely does one Washington regulator engage in such a public, pitched battle with other agencies. Born's failed effort is part of the larger story of what led to today's financial chaos, a bipartisan story of missed opportunities and philosophical shifts in which Washington stood impotent as the risk of Wall Street innovation swelled, according to more than 60 interviews as well as transcripts of meetings, congressional testimony and speeches. (Born declined to be interviewed.) Derivatives did not trigger what has erupted into the biggest economic crisis since the Great Depression. But their proliferation, and the uncertainty about their real values, accelerated the recent collapses of the nation's venerable investment houses and magnified the panic that has since crippled the global financial system.

Futures contracts, one of the earliest forms of a derivative, have long been associated with big market failures. Harry Truman's father was financially wiped out by agriculture futures, and rampant manipulation by speculators contributed to the market collapses of 1929. Regulators have long known that new trading instruments have a way of giving reassurance of stability in good times and of exacerbating market downturns in bad.

Futures -- essentially, a promise to deliver cash or something of value at a later time -- are traded on regulated exchanges such as the Chicago Mercantile Exchange, regulated by the CFTC. But Born was not questioning bets on pork bellies or wheat prices, the bedrock of futures trading in simpler times. Her focus was the arcane class of derivatives linked to fluctuations in currency and interest rates. She told a group of business lawyers in 1998 that the "lack of basic information" allowed traders in derivatives "to take positions that may threaten our regulated markets or, indeed, our economy, without the knowledge of any federal regulatory authority."

The future that Born envisioned turned out to be even riskier than she imagined. The real estate boom and easy credit of the past decade gave birth to more complex securities and derivatives, this time linked to the inflated value of millions of homes bought by Americans ultimately unable to afford them. That created a new chain of risk, starting with the heavily indebted homebuyers and ending in a vast, unregulated web of contracts worldwide.

By appearing to provide a safety net, derivatives had the unintended effect of encouraging more risk-taking. Investors loaded up on the mortgage-based investments, then bought "credit-default swaps" to protect themselves against losses rather than putting aside large cash reserves. If the mortgages went belly up, the investors had a cushion; the sellers of the swaps, who collected substantial fees for sharing in the investors' risk, were betting that the mortgages would stay healthy.

The global derivatives market topped $530 trillion as of June 30 this year, including $55 trillion in the suddenly popular credit-default swaps; that $530 trillion represents all contracts outstanding. The total dollars at risk is much smaller, but still a hefty $2.7 trillion, according to an estimate by the International Swaps and Derivatives Association. To make sense of those figures, compare them to the value of the New York Stock Exchange: $30 trillion at the end of 2007, before the recent crash. When the housing bubble burst and mortgages went south, the consequences seeped through the entire web. Some of those holding credit swaps wanted their money; some who owed didn't have enough money in reserve to pay.Instead of dispersing risk, derivatives had amplified it.

Born, after 30 years in Washington, found herself on President Bill Clinton's short list for attorney general in 1992. The call never came. Approached about the CFTC job four years later, she took it, seeing a chance to make a public service mark, colleagues say. For several years before Born's arrival at the futures commission, Washington had been hearing warnings about derivatives. In 1993, Rep. Jim Leach (R-Iowa) issued a 902-page report that urged "regulations to protect against systemic risk" as well as supervision by the SEC or Treasury. Sen. Donald W. Riegle (D-Mich.), while acknowledging that swaps helped manage risk, saw "danger signs, on the horizon" in their rapid growth. He and Rep. Henry Gonzalez, a Texas Democrat, introduced separate bills in 1994 that went nowhere. Mary Schapiro, Born's predecessor, made her own run at the issue through enforcement actions.

In an earlier decade, President Ronald Reagan had described the CFTC as his favorite agency because it was small and it had allowed the futures industry to grow and prosper. Born swept into the agency, the least known of the four major regulators with primary responsibility for overseeing the nation's financial markets, determined to enforce its rules and tackle hard issues. "One theory at the time was she was so disappointed not to be running Justice -- that she got this tiny agency as a consolation prize and was hell-bent to make it important. I'm not sure that was in her mind, but it was a point of criticism," said John Damgard, president of the Futures Industry Association. Damgard disagreed with Born's approach but said he respected her for fighting for her principles.

Daniel Waldman, Born's law partner at Arnold and Porter and her general counsel at the futures commission, said Born let the industry know she meant business. "She got into a knock-down, drag-out fight with the Chicago Board of Trade over the delivery points for soybean contracts," he recalled. "She believed it was her obligation under the statute to review decisions by the exchanges. If they didn't meet agency requirements, she was going to say so, not look the other way." Born didn't back off on derivatives, either. On May 7, 1998, two weeks after her April showdown at Treasury, the commission issued a "concept release" soliciting public comment on derivatives and their risk.

The response was swift and blistering. Within hours, Greenspan, Rubin and Levitt cited their "grave concerns" in an unusual joint statement. Deputy Treasury Secretary Lawrence Summers decried it before Congress as "casting a shadow of regulatory uncertainty over an otherwise thriving market." Wall Street howled. "The government had a legitimate interest in preserving the enforceability of the billions of dollars worth of swap contracts that were threatened by the concept release," said Mark Brickell, a managing director at what was then J.P. Morgan Securities and former chairman of the International Swaps and Derivatives Association.

Although Born said new rules would be prospective, Wall Street was afraid existing contracts could be challenged in court. "That meant anybody on a losing side of a trade could walk away," Brickell said. He spent months shuttling between New York and Washington, working on Congress to block CFTC action. "I remember getting on an overnight train and arriving at Rayburn by 5:30 a.m.," he said. "I watched the sun rise and then went to work on my testimony without a whole lot of sleep."

Born, who testified before Congress at least 17 times, tried to counter the legal question by saying that regulation would apply only to new contracts, not existing ones. But she relentlessly reiterated her conviction that ignoring the risk of derivatives was dangerous.In June 1998, Leach, who had become chairman of the House Banking committee, thrust himself into the regulatory rift. He herded Born, Rubin and Greenspan into a small room near the committee's main venue at the Rayburn House Office Building, thinking he could mediate. "This is the most unusual meeting I've ever participated in," Leach recalled. "I have never in my life been in a setting where three senior members of the U.S. government reflected more tension. Secretary Rubin and Chairman Greenspan were in concert in expressing frustration with the CFTC leadership. . . . She felt, I'm confident, outnumbered with the two against one."

Leach thought the futures commission lacked the professional bench to handle oversight. He pressed Born not to proceed until the Treasury and the Fed could agree which agency was best suited to the role. "I tried to take the perspective of, 'I hope we can work this out,' " he said. "Both sides -- neither side, gave in." Rubin said, in the recent interview, that he had his own qualms about derivatives, going back to his days as a managing partner at Goldman Sachs. He later wrote in a 2003 book that "derivatives, with leverage limits that vary from little to none at all, should be subject to comprehensive and higher margin requirements," forcing dealers to put up more capital to back the swaps. "But that will almost surely not happen, absent a crisis."

Asked why he didn't suggest stricter capital requirements as an alternative in 1998, Rubin said, "There was no political reality of getting it done. We were so caught up with other issues that were so pressing. . . . the Asian financial crisis, the Brazilian financial crisis. We had a lot going on." When the warring parties faced off next, in the Senate Agriculture committee's hearing room July 30, 1998, it was not a neutral battleground to air their differences. Chairman Richard G. Lugar, an Indiana Republican, wanted to extract a public promise from Born to cease her campaign. Otherwise, Congress would move forward on a Treasury-backed bill to slap a moratorium on further CFTC action.

The committee had to switch to a larger room to accommodate the expected crowd of lobbyists representing banks, brokerage firms, futures exchanges, energy companies and agricultural interests, according to a Lugar aide. A dubious Lugar opened the hearing by telling Born: "It is unusual for three agencies of the executive branch to propose legislation that would restrict the activities of a fourth." Born would not yield. She portrayed her agency as under attack, saying the Fed, Treasury and SEC had already decided "that the CFTC's authority should instead be transferred to and divided among themselves."

Greenspan shot back that CFTC regulation was superfluous; existing laws were enough. "Regulation of derivatives transactions that are privately negotiated by professionals is unnecessary," he said. "Regulation that serves no useful purpose hinders the efficiency of markets to enlarge standards of living." The stalemate persisted. Then, in September a crisis arose that gave credence to Born's concerns.

Long Term Capital Management, a huge hedge fund heavily weighted in derivatives, told the Fed that it could not cover $4 billion in losses, threatening the fortunes of everyone from tycoons to pension funds. After Russia, swept up in the Asian economic crisis, had defaulted on its debt, Long Term Capital was besieged with calls to put up more cash as collateral for its investments. Based on the derivative side of its books, Long Term Capital had an astoundingly high debt-to-capital ratio. "The off-balance sheet leverage was 100 to 1 or 200 to 1 -- I don't know how to calculate it," Peter Fisher, a senior Fed official, told Greenspan and other Fed governors at a Sept. 29, 1998, meeting, according to the transcript.

Two days later, Born warned the House Banking committee: "This episode should serve as a wake-up call about the unknown risks that the over-the-counter derivatives market may pose to the U.S. economy and to financial stability around the world." She spoke of an "immediate and pressing need to address whether there are unacceptable regulatory gaps." The near collapse of Long Term Capital Management didn't change anything. Although some lawmakers expressed new fervor for addressing the risks of derivatives, Congress went ahead with the law that placed a six-month moratorium on any CFTC action regarding the swaps market.

The battle left Born politically isolated. In April 1999, the President's Working Group issued a report on the lessons of Long Term Capital's meltdown, her last as part of the group. The report raised some alarm over excess leverage and the unknown risks of the derivative market, but called for only one legislative change -- a recommendation that brokerages' unregulated affiliates be required to assess and report their financial risk to the government. Greenspan dissented on that recommendation.

By May, Born had had enough. Although it was customary at the agency for others to organize an outgoing chairman's going-away bash, she personally sprang for an ice cream cart in the commission's beige-carpeted auditorium. On a June afternoon, employees listened to subdued, carefully worded farewells while serving themselves sundaes. In November, Greenspan, Rubin, Levitt and Born's replacement, William Rainer, submitted a Working Group report on derivatives. They recommended no CFTC regulation, saying that it "would otherwise perpetuate legal uncertainty or impose unnecessary regulatory burdens and constraints upon the development of these markets in the United States."

Throughout much of 2000, lobbyists were flying in and out of congressional offices. With Born gone, they saw an opportunity to settle the regulatory issue and perhaps gain even more. They had a sympathetic ear in Texas Sen. Phil Gramm, the influential Republican chairman of the Senate Banking Committee, and a sympathetic bill: the 2000 Commodity Futures Modernization Act. Gramm opened a June 21 hearing with a call for "regulatory relief." Peering through his wire-rimmed glasses, he drawled: "I think we would do well to remember the Lincoln adage that to ask a society to live under old and outmoded laws -- and I think you could say the same about regulation -- is like asking a man to wear the same clothes he wore when he was a boy."

Greenspan and Rubin's successor at the Treasury, Larry Summers, still held sway on keeping the CFTC out of the swaps market. But Treasury officials saw an opportunity to push forward on a self-regulation idea from the Working Group's November 1999 report: an industry clearinghouse to hold pools of cash collected from financial firms to cover derivatives losses. But the report had also called for federal oversight to ensure that risk-management procedures were followed. The swaps industry generally supported the clearinghouse concept. One amended version of the bill made federal oversight optional. Treasury officials scrambled to act, and a provision introduced by Leach requiring oversight prevailed.

The House passed the bill Oct. 19, but then the legislation stalled. Gramm was holding out for stronger language that would bar both the CFTC and the SEC from meddling in the swaps market. Alarmed, SEC lawyers argued that the agency at least needed to retain its authority over fraud and insider trading. What if a trader, armed with inside knowledge, engaged in a swap on a stock? Treasury Undersecretary Gary Gensler brokered a compromise: The SEC would retain its antifraud authority but without any new rulemaking power.

On the night of Dec. 15, with the nation still focused on the Supreme Court decision three days earlier that settled the 2000 presidential election in George W. Bush's favor, the act passed as a rider to an omnibus spending bill. The clearinghouse provision remained. At the time, it seemed like a breakthrough. A clearinghouse would have created layers of protections that don't exist today, said Craig Pirrong, a markets expert at the University of Houston. "An industry-backed pool of capital could have cushioned against losses while discouraging risky bets." But afterward, the clearinghouse idea sat dormant, with no one in the industry moving to put one in place.

In 2004, the SEC pursued another voluntary system. This one, too, didn't work out quite as hoped. For years, Congress had allowed a huge gap in Wall Street oversight: the SEC had authority over the brokerage arms of investment banks such as Lehman Brothers and Bear Stearns, but were in the dark about deals made by the firms' holding companies and its unregulated affiliates. European regulators, demanding more transparency given the substantial overseas operations of U.S. firms, were threatening to put these holding companies under regulatory supervision if their American counterparts didn't do so first.

For the SEC, this was deja vu. In 1999, the SEC had sought such authority over the holding companies and failed to get it. Late in the year, Congress passed the Gramm-Leach-Bliley Act, dismantling the walls separating commercial banks, investment banks and insurance companies since the Great Depression. But the act did not provide for any SEC oversight of investment bank holding companies. The momentum was all toward deregulation. "I remember saying at the time, people don't get it -- the level of missed opportunities to address some of these problems," said Annette Nazareth, then the SEC's head of market regulation. "It was an absolute siege on regulation."

Five years later, the European regulators were forcing the issue again. Restricted by Gramm-Leach-Bliley, the SEC proposed a voluntary system, which the big investment banks opted to join. The holding companies would be permitted to follow their own computer models to assess how much risk they were taking; the SEC would get access to make sure the complex capital and risk-management models were up to the job. At an April 28 SEC meeting, commissioner Harvey Goldschmid expressed caution. "If anything goes wrong, it's going to be an awfully big mess," said Goldschmid, who voted for the program.

Last month, the SEC's inspector general concluded that the program had failed in the case of Bear Stearns, which collapsed in March. SEC overseers had seen Bear Stearns's heavy focus on mortgage-backed securities and over-leveraging, but "did not take serious action to limit these risk factors," the inspector general's report said. SEC officials say the voluntary program limited what they could do. They checked to make sure Bear Stearns was adhering to its risk models but did not count on those models being fundamentally flawed.

On Sept. 26, with the economic meltdown in full swing, SEC Chairman Christopher Cox shut down the program. Cox, a longtime champion of deregulation, said in a statement posted on the SEC's Web site, "the last six months have made it abundantly clear that voluntary regulation does not work." It was too late. All five brokerages in the program had either filed for bankruptcy, been absorbed or converted into commercial banks.

On Sept. 15, 2005, Federal Reserve Bank of New York president Timothy F. Geithner gathered senior executives and risk-management officers from 14 Wall Street firms in the Fed's 10th-floor conference room in lower Manhattan for another discussion about a voluntary mechanism. Also arrayed around the wood rectangular table, covered by green-felt tablecloths, were European market supervisors from Britain, Switzerland and Germany.

E. Gerald Corrigan, managing director of Goldman Sachs and one of Geithner's predecessors at the New York Fed, had reported in July that the face value of credit-default swaps had soared ninefold in just three years. Without an automated, electronic system for tracking the trades or collateral to back them, the potential for systemic risk was increasing. "The growth of derivatives was exceeding the maturity of the operational infrastructure, so we thought we would try to narrow the gap," Geithner said in an interview. Talks have continued on a range of issues, including how to set up a clearinghouse with reserves in case of default -- the same concept in the 2000 legislation -- and what kind of government oversight would be allowed. But three years later, there is no system in place. Some major dealers have preferred to go it alone, and no one in the government told them they couldn't.

With last month's death spiral of American International Group, the world's largest private insurance company until it was seized by the government, regulators saw their fears play out. AIG had sold $440 billion in credit-default swaps tied to mortgage securities that began to falter. When its losses mounted, the credit-rating agencies downgraded AIG's standing, triggering a clause in its credit-default swap contracts to post billions in collateral that it didn't have. The government swooped in to prevent AIG's default, hoping to ward off another chain reaction in the already shaky financial system.

The economic crisis has added momentum to the Fed's attempts to organize a voluntary clearinghouse. Geithner held two meetings last week with several firms and major dealers interested in setting up such a mechanism. Last week, the Chicago Mercantile Exchange announced it would team with Citadel Investment Group, a large hedge fund, to launch an electronic trading platform and clearinghouse for credit-default swaps. Other private companies and exchanges are working on their own systems, seeing opportunities for profit in becoming a shock absorber for the system.

The crisis has prompted second thoughts. Goldschmid, the former SEC commissioner and the agency's general counsel under Levitt, looks back at the long history of missed opportunities and sighs: "In hindsight, there's no question that we would have been better off if we had been regulating derivatives -- and had a clearinghouse for it." Levitt, too, thinks about might-have-beens. "In fairness, while Summers and Rubin and I certainly gave in to this, we were not in the same camp as the Fed," he said. "The Fed was really adamantly opposed to any form of regulation whatsoever. I guess if I had to do it over again, I certainly would have pushed for some way to give greater transparency to products which turned out to be injurious to our markets."

Your story reminds me of my business partner here in France. He is Canadian, his parents came from Russia, fleeing some sort of persecution, had their children very late in life, etc.

Anyway, what pushed me to respond was this:I have been told that it is dangerous to take them out as no one can time the market and no one knows where the bottom lies.

That is the classic line intended to make you sit on your investments until the market comes back up. My brother has exactly that opinion even today!

But, as I told him one year ago, if the market is heading down for a long time, simply pull your money out as soon as possible. We are not talking about timing the market, but rather about saving what is still to be saved.

Stoneleigh thinks we may be looking at a rebound coming up. Given how things stand today, you might as well try to take advantage of some of that rebound. If you have seen no progress in the next few weeks, then I would sell.

BUT, do not take my word for it, ask around, look for other opinions, particularly from people capable of looking at your holdings and making an informed decision.

I know another person, who predicted the end of the USSR and financial crash of the USA in early 80's.

His name is Jiri Polak, he's Doctor of Politology - international relations.

Watch at http://www.demokracie.info/index.php?id_kategorie=8

for the contact. He speaks English well, better than me and I'm sure he'll reply your question quickly.

When I talked to him last time, early this summer, he told me that it is too late to fix ill US economzy They're awaiting the total state bancrot already. Followed by worldwide crash of economy. The economs will be forced to found the new way, how the economy will work in the future.

Re the Freaky Lizard link- can this be a real photo. In what context was McCain behaving this way.Was he joking around? He looks like he is having a heart attack or something? I didn't watch the debate- no television.

Came across a great quote on Jesse's Cafe Americain:" Those entrapped by the herd instinct are drowned by the deluges of history. But there are always the few who observe,reason, and take precautions and thus escape the flood." Anthony C. SuttonNumbered in the few are Ilargi and Stoneleigh

That picture, and the title Reuters filed it under, are real funny. I thought all night long last night that he looked like a lizard, and wrote about it this morning, without seeing that pic. Guess i wasn't the only on thinking of a big wet sticky 3 meter green tongue coming out of the jab any moment now. Thanks for the pic.

Bigelow -- I have no idea what the market will do, and if I did you could make a large fortune using me as a contrary indicator!! That said, I sincerely hope you are right about a rally coming -- I think we probably all have friends and family that need to sell in to it - if we can only persuade them to take that step! --(In this case, forget what I said about me being a contrary indicator...I'm just following the lead of Ilargi and Stoneleigh! Unfortunately, I am not nearly as persuasive as they are.)

Bigelow -- Forgot to add that my main worry is that the market never seems to do what you need it to do...and hope turns into dispair. (And that is a very brief but complete history of my experience trading stocks and options in a different lifetime.)

Re the Freaky Lizard link- can this be a real photo. In what context was McCain behaving this way.Was he joking around? He looks like he is having a heart attack or something? I didn't watch the debate

I didn't watch the debate either. It's all such a farce.

My guess is that McCain was told by his handlers to act 'young and vibrant.' After mistakenly turning the wrong way off stage, he decided to (over)compensate by making the over-the-top animated facial expression.

Re the Freaky Lizard link- can this be a real photo. In what context was McCain behaving this way.Was he joking around? He looks like he is having a heart attack or something? I didn't watch the debate

I didn't watch the debate either. It's all such a farce.

My guess is that McCain was told by his handlers to act 'young and vibrant.' After mistakenly turning the wrong way off stage, he decided to (over)compensate by making the over-the-top animated facial expression.

Dark matter..Rabbits love Himalayan blackberries,the invasive species that is the same as living bob-wire all around my place.They like the shoots best,but will munch all the leaves you give them.This was a trick that the guy who supplied Fred Meyers stores w/rabbit taught me.The old boy lived up the road from me with his wife in a run-down trailer w/a processing house still attached.The name of his company was 'the violin rabbit company"which was a play on their names Violet and Lynn.He was well known in the rabbit world ,as a supplier of breeding stock to several countries...I was wise enough to soak up everything i could from him about raising bunnies.[I still have contact info to the pres. of the state rabbit org.ect for good breeding stock ect].This was a example of a old guy who started a business from nothing and handed over to a young couple who broke it in 6 months

If there is a interest Sparkle,There is always good Chinese,Korean,Lebanese,East Indian,Spanish ect. food in stumptown Any guess how many readers are from here in PDX?

Thanks for the photo of the fake smile, drugged lizard (poor lizards!). We had a good laugh, our sons were rolling. They can't stand McCain and are looking forward to vote for Obama. My husband and I are so disgusted with one party system that for a while we contemplated not participating in federal elections at all. However, we have decided to vote for Obama (no viable Greens in US) despite being cognizant that the handlers probably won't allow the execution of any reforms, assuming Obama is willing and gets to the White House. I wonder if elections will be rigged again -- 2000 and 2004 election-rigging is well documented.

McCain and Palin are dangerous, scary people. I'd rather see Obama, a more balanced person, in the White House in charge of nukes and managing the sinking Titanic than John McNut.

GEAB 28: "...our researchers anticipate that, before next summer 2009, the US government will default and be prevented to pay back its creditors... According to our team, the period that will then begin should be conducive to the setting up of a « new Dollar » to remedy the problem of default and of induced massive capital drain from the US."

They also predict the Euro becomes a "credible safe haven." I was thinking the other day about how accurate their bulletins have been--but their political ambitions may blind them on outcomes.

So much for that story. A few days ago, when Hank Paulson called the heads of the nine families to Washington and shoved cash down their throats, he announced that the banks would use this new taxpayer cash to lend. They won't, of course. They'll hoard it like a starving family who has just been given a grocery cart full of food.

And after a few days of silence, even the banks are finally admitting that. So it's back to the drawing board for Paulson & Co.

Next steps? Find a way to force the banks to write their assets down to nuclear winter levels, so 1) private investors don't have to worry about getting sandbagged and therefore invest more in the banks, and 2) the banks know they won't be forced to take more multi-billion dollar losses. Only then will the banks begin to lend again. And at that point, the only challenge will be finding people and companies to lend to, in an economy headed straight into the tank.)

NYT: , John Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view.

“We will have the opportunity to redeploy that,” Mr. Thain said of the new capital on a telephone call with analysts. “But at least for the next quarter, it’s just going to be a cushion."...

“I don’t think that the market wants to see that capital being put to work to leverage the business up again,” said Roger Freeman, an analyst at Barclays Capital, which acquired parts of the now-bankrupt Lehman Brothers last month. “My expectation is it’s quarters off, not months off, before you see that capital being put to work.”...

Jamie Dimon, the chairman and chief executive of JPMorgan, said his bank was in a stronger position to use the money than some of its competitors.

“It’s clear that the government would like us to use the capital,” Mr. Dimon said on a conference call with analysts on Wednesday. “If you are a bank that is filling a hole, you obviously can’t do that.”

Who is "a bank that is filling a hole"? Seven of the nine that just got taxpayer money.

I think that the TED is dropping like hell because the 3m T-bill is going up like crazy today. Currently at .85%. Wasn't it like .22% a couple of days ago? Did Hankenstein announce that the treasury was defaulting on Monday :-) This may not representing a melt of the credit markets, but rather resistance to T-Bills. But that said, I am a plumber and don't know shit about it.

Thanks el pollo, but hey as far as knowing what is what, I don't even have a site to watch US T bills on!(don't tell ilargi but if I didn't figure I need to be watching this economic stuff I would be on the beach in Mexico painting pictures to chuck in the ocean). Do you think Warren Buffet trying to buy low today, and shouting all about it, had any influence?Then again thinking that over I guess Buffet could maybe influence the stock market but not something like T bills. (don't ask me for investment advice, not wise.)

How is Tony Hankenstein going to cut interest rates further? Even the BofJ is not willing to drop its funds rate to an negative number - i.e. (at least on a nominal basis) pay people to borrow money.

As deflation sets into the real economy, including plummeting commodities, our savings should be appreciating on a real basis. As of Monday's auction, I should have 90% of my egg in currency and 13w T-bills. The other 10% is for day trading and the Tip Jar :-)

P.S.Hurricane Omar made a little hop and shuffle to the east at the last second while doing 120 mph and missed my hovel by 30 miles. Otherwise my Neanderthal presence would just be a grease spot on a rock. Omar was compact but cute.